Taxpayers with stock compensation
Individuals receiving income in the form of stock may want to consider the benefits of an 83(b) election. With an
83(b) election, you pay the tax liability on restricted shares at the time of grant versus when the shares vest. If
the underlying stock has recently decreased in value, but you expect it to increase substantially, paying the income
tax upfront and capital gains tax on any future appreciation may be more beneficial. However, there is risk of
paying additional tax in the event the value falls in the time between making the election and the time the shares
vest. There are specific rules surrounding 83(b) elections that must be followed, including filing the election
within 30 days of receiving the restricted stock award. Make sure you check with your tax professional before
implementing this strategy.
Buy and hold strategies
In addition, buy and hold strategies with stock options may prove beneficial. If the value of the stock is
depressed, but is still greater than the strike price, exercising the options now and holding the shares until they
increase in value may make sense. This strategy could lower your current tax liability and allow future appreciation
to potentially be subject to (currently lower) long-term capital gains tax rates rather than higher ordinary income
Monitoring legislative changes
Another consideration for those with significant stock compensation is changes in legislation. If ordinary income
and/or long-term capital gains rates increase in future years, recognizing income now through the exercise of
options or recognizing long-term capital gains may be beneficial. Be sure to speak with your advisor before year-end
to determine what strategies are applicable depending upon the environment.
Incentive stock options
If you have incentive stock options (ISOs), do not forget about potential exposure to the alternative minimum tax (AMT).
While you typically do not have to report when the ISO is granted or when you choose to exercise it as part of your gross
income for the year, you may be subject to the AMT in the year that you exercise it. This is because the “bargain element”
(the difference between the grant price of the ISO and the fair market value of the security when it is purchased via the
exercise of the ISO) must be reported. This amount is generally treated as a capital gain or capital loss for tax purposes.
Although the TCJA increased the AMT exemption (thus, reducing the number of people subject to AMT), those exercising ISOs
need to include this bargain element as a positive adjustment for alternative minimum taxable income.
Also, if the underlying stock has dropped after exercise, you may want to consider selling the shares and paying income tax
on the new difference between fair market value and the exercise price. This process, called a disqualifying disposition,
can provide liquidity to pay the tax if the stock has dropped after exercising the ISO.
Finally, be aware that the income from the sale of securities could be taxed at ordinary income rates if IRS requirements
for holding securities from the exercised ISO are not met.
As we have discussed throughout the guide, any final decisions on your personal tax strategy should be made after consulting
your tax, legal, and financial advisors. The election outcome is likely to provide additional clarity on the outlook for 2021
tax rates. Furthermore, managing income can be combined with other strategies discussed later in this guide to help pursue your
specific objectives and lower your tax liability.