Remember how (and if you don’t, go back and reread our last blog post) I recommended that you consider converting pre-tax money in your IRAs or 401(k)s to a Roth account, because tax rates are low now compared to what they will be if the TCJA expires? And we want to incur taxable income when tax rates are lower?
Well, the exact same logic applies to the idea of exercising non-qualified stock options (NSOs).
When you exercise an NSO, you immediately owe income tax on the “spread” between the exercise price and the value of the stock.
Let’s say you exercise one NSO at a strike price of $1 with a share price of $10 (be that the price on the stock market for a public company, or the 409(a) value for a private company). That gives you $9 of taxable income.
Most people aren’t thinking about just one option. So, let’s think about 10,000 NSOs. In the exact price scenario above, you’d immediately have $90,000 of taxable income.
Behold the tax brackets and tax rates below, which is what they are now, and what they will be if the TCJA expires. Imagine that you’re single and your salary + bonus is $500k/year. If you exercise NSOs now, that generates an extra $90k of taxable income, all of that will be taxed at 35%. If you exercise post-TCJA expiration, then a little of that $90k will be taxed at 33%, a little at 35%, and most of it at 39.6%. Which, let’s review, is higher than 35%.
If you look long enough at the chart below, you can see that in some income scenarios, you’ll actually have a lower top tax rate post-TCJA than now. You’d need to run the numbers for your own specific situation to make sure.
