I frequently encounter clients who have experienced significant wealth growth, often quite rapidly. Yet, finding a story truly worth sharing is a rarity. Recently, I had the privilege of working with a young individual who had a slight windfall. His former employer’s stock options, acquired during his tenure, skyrocketed in value over a short few weeks, leaving him with not only a substantial sum of money but also a big decision to make in terms of whether to exercise these options. Luckily this person had a good understanding of tax mitigation and was aware he may be in them of the alternative minimum tax (AMT) for when he goes to file his tax return this year.
For readers that do not know here is a simple explanation of what Alternative Minimum tax is. AMT is a secondary tax system that ensures high-income earners pay a minimum amount of tax. It’s designed to prevent people from using tax deductions and credits to avoid paying their fair share. If your regular tax is lower than the AMT, you’ll have to pay the higher amount.
To start I brought in a specialist in AMT tax consideration and we worked to see what our best option would be for this person based on their current income, future income, and other financial future plans. From here, we were able to dial up exactly how much would be best for this person to exercise and sell. It is important to note also that this prospect did not just have qualified stock options (the only type that would be affected by AMT) but also non-qualified stock option quantities.
For us, we found it would be best to exercise and sell all the stock options. Why?
Well, here is a few reasons. For one this individual had a strict 90-day window to make up his mind before these stock options expired… Essentially, they dissolve and no value is awarded to them. Also, we did not know where the stock was going to go next. Sure, we ran an evaluation of this former company and all looked great… But could we truthfully say that could keep going?
Also, a very overlooked idea that came down to a large piece of our decision was his marginal tax rate. Historically we have time and time again seen taxes rise. Not to mention depending on how the election goes we could potentially see the end of the Tax Cut and Jobs Act (TCJA). This is the bill which cuts and lowers taxes for all Americans. When putting all these factors into place for our friend here it was rather an easy situation.
Sure, you will have to pay a large chunk of taxes upfront however would not you rather do that at a lower rate now than later? Furthermore … who knows if that value will even be the same if the company’s stock price begins to slide.
Now we can move these funds to a more diverse portfolio for the individual and start planning to work toward his financial goals. I know this is a small and short piece that summarizes a lot of moving parts or planning and tax considerations but it was something I felt would benefit a lot of my readers. Most importantly I would like to add if anyone feels they have even the slightest bit of resemblance to this individual please let your advisor know so that you too can coordinate before you let an amount expire worthless or over/under pay on your taxes. As advisors we are not tax professionals but we can lead you to the trusted contacts that are.
Good Luck and enjoy your week!
Disclaimer: The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for individualized tax advice. We suggest that you discuss your specific tax situation with a qualified tax advisor
Investing involves risk including loss of principal. No strategy assures success or protects against loss.
