Giving up on ISOs - the right thing to do?

An interesting campaign launched this week. The key argument is that 90 day post-termination exercise requirements - typical for stock options granted by startups - are not fair to rank-and-file employees.

The case is well made by Harjeet, in what appeared to be a coordinated brace of posts on Medium, published yesterday:

Those of you familiar with tax law requirements for ISOs (incentive stock options) will be quick to say, "well, that tight exercise window is required by the law; it's part of the tradeoff for the employee getting the favored tax treatment of ISOs."

6108085408_8d79bbe1c2_bBut Harjeet is arguing that the tax benefits of ISOs are outweighed by the impracticalities of the 90 day post-termination exercise window.

And are those tax benefits as significant as many assume? Here's part of his discussion of the tax benefit lost on exercise of the stock option as a non-qualified stock option, which is necessarily what you get when you extend the post termination exercise window and so fall outside ISO requirements:

"ISO: Employee now owes AMT (Alternative Minimum Tax) on the difference between the amount they paid to exercise their options (the exercise price) and the fair market value of that stock today. Calculating exactly AMT can be tricky, most likely you’ll pay 28% on the difference."

"NSO: Employee owes Ordinary Income Tax (38%) on the difference between the exercise price and fair market value of the stock."

So ISO treatment is not as compelling for tax reasons as one might suppose. My friend, the startup lawyer, Joe Wallin, has been pointing this out for years.

There are company-side factors in favor of a 90-day post-termination exercise window that are not emphasized by Harjeet's posts. Startup founders, management teams and boards are going to want to consider these other factors. At the same time, Harjeet's posts are  very well done and make a compelling, pro-employee case. I think his arguments are a great contribution to the discussion.

Photo credit: Nisa Yeh, Creative Commons license.

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