You Make the Call - July 20, 2023

Question: Our client, Sara, does consulting work for a private company, which gave her 1 million options at a $0.01 strike price. Sara will only have 90 days to exercise the shares once leaving the company. Though the 409a valuation reflects a stock price of $0.01, the shares currently have a market value of $0.50. What are the tax results if Sara were to exercise her options?

Answer: The type of stock options Sara received will determine the tax consequences. She will need to use the option agreement to verify whether these are qualified incentive stock options or non-qualified stock options. However, incentive stock options are generally not granted to non-employees. Therefore, your client probably received a non-qualified stock option.

Non-qualified stock options are a type of employee stock option where you pay ordinary income tax on the difference between the exercise price, which, in this case, is $0.01, and the FMV of the stock when the option is exercised, which would be $0.50. When the client sells the stock, they will then be taxed at capital gains rates for the difference between $0.50 cost basis and the price actually received upon sale. Depending on how long the client holds the stock between the time they exercise it and sell it will determine whether the gain will be subject to short term or long-term capital gains tax.