By Chuck Steege. Many private company employees holding stock options are looking for tax strategies prior to the company’s public offering. A lesser-known provision for pre-IPO options exercise allows employees holding ISO-options to lock in a lower pre-IPO price in order to minimize ordinary income taxes and start the capital gains period running during the pre-IPO period.
Now, under a Bill before the U.S. Senate, HR 5719, eligible employees could defer taxes on the pre-IPO exercise transaction, making the transaction more attractive for executives and employees. If HR 5719-Empowering Employees Through Stock Ownership Act passes the Senate in a lame duck session, a private company employee could elect to defer the income and Federal taxes on the income from an early ISO exercise for up to seven years (or until the stock becomes tradable on an established securities market). The Bill passed in the House during September.
While CEOs may understand pre-IPO options exercise, other employees may not be aware, and even if they were, the total transaction costs including immediate taxes might deter them from moving ahead with the potentially longer-term tax-saving transaction.
Under the new legislation, the private company employee’s immediate cost to exercise would be limited to the option strike price and other taxes – excluding Federal. Certain exclusions apply for the top four executives of the company or those holding a position of 1% or greater of the company’s outstanding shares. The Bill has been moved to the Senate for consideration.
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Chuck Steege is President of SFG Wealth Planning Services, Inc., SFG Investment Advisors, Inc. (SFG), a fee-only financial planning firm. Founded in 1993, SFG is dedicated to assisting senior executives and their employees with their complex stock-based compensation and planning challenges.