ISO - Cashless Transaction

[taxes---taxes]

Employee exercised incentive stock option on 2,000 shares costing $27k. He did a cashless transaction whereby he sold 800 shares for $37k part of which he used to fund the purchase. From this, $5k was deducted in fed tax and $2k in state tax leaving a net of $3k. Presumably, these tax amounts are already reported on the W2. The 800 shares were reported on a 1099-B and included some shares that satisfied the holding period which are to be taxed as LTCG.

Now does it matter if the remaining 1,200 shares that the employee holds (2,000 - 800) came about in a cashless transaction when it comes to figuring AMT? The diff between the FMV on exercise date and the exercise price is $46k so normally that would be subject to AMT but not sure if it matters if it was cashless or not.

[itonewbie · Accepted solution]

"The 800 shares were reported on a 1099-B and included some shares that satisfied the holding period which are to be taxed as LTCG."

The exersale of 800 shares constitutes disqualifying disposition and should result in a slight STCL because of transaction costs.  These should be separately identified from the existing shares he's been holding LT and sold.

Since the 800 shares sold in the disqualifying disposition are subject to regular tax already, only the remaining 1,200 shares would be subject to AMT.  It does not matter that these shares were purchased through a cashless exercise (it's the same as paying cash with after-tax money and this sum just happened to have come from a disqualifying disposition of the ISO).

[rbynaker]

itonewbie nailed it (as usual!)

"The 800 shares were reported on a 1099-B and included some shares that satisfied the holding period which are to be taxed as LTCG."

I guess it's mathematically possible that some of the 800 shares sold were NOT from this ISO exercise, but I've NEVER seen it done that way (and I think, if it were, we wouldn't be able to call it "cashless" anymore).  A hypothetical:

ISOs granted 3 years ago, exercised 2 years ago (not relevant how paid for) and held until today.
Different set of ISOs granted 2 years ago, exercised today.
Sold shares from 3-yr-old ISO grant with 2-yr holding period to pay for today's exercise.

But I've only seen where a piece of the current lot was sold to pay the exercise, and there's no way that would be a qualified holding period and/or LTCG.

"Presumably, these tax amounts are already reported on the W2."

I've seen this screwed up enough to never presume anything.  Get the exercise reports, get the year-end paystub and compare all of the data you have with 1) what should have happened according to tax law, and 2) what was actually reported on the W-2 and 1099-B.

Generally the Fortune 500 / large public companies get this right.  But I deal with a lot of tech companies and "beltway bandit" smaller government contractor firms and these things can go sideways in a hurry if the firm doesn't have the right team in charge of the accounting.  It can be like the blind leading the blind.

ISOs are not nearly as prevalent now (I suspect because all of the executives got hit with AMT and realized this wasn't actually saving them any taxes!) but I remember this was a huge mess back before the tech bubble burst.

Rick

[itonewbie]

Yeah, back in the 90's, we saw so many folks who had AMT and continued to carry them for years without being able to clear them with MTC.

[rbynaker]

I have a client who I think still has some MSTR stock with a different AMT basis.  I used to track it in Quicken files.  One "account" would be Regular Tax Basis, another account would have the exact same holdings but with AMT basis.

[hcliston]

Thanks for this. I also have a client who did an exer-sale of ISOs during 2020. 

Your info about the disqualifying transaction is helpful.  I am entering this as an exercise of NSOs, and the bargain element is showing up correctly on his W-2, so all is well there. 

Just one more procedural question: In ProSeries, I entered the exercise on the "Exercise of Stock Options Worksheet."  But where do I enter the SALE of those same shares?  The worksheet specifically says that section is for options exercised and held (not sold) in 2020. 

Thank you!