Stock options can be an incredibly lucrative part of your compensation.
But if you're leaving your company, you may have some big decisions to make, and potentially a very limited amount of time to make them.
Some options may be forfeited immediately. Others may expire shortly after you leave. Exercising them could also require a significant amount of cash and potentially create a surprise tax bill.
That's why the planning should start before your final day.
Start by reviewing what you own
Before leaving, gather your stock plan, individual grant agreements and any separation documents provided by your company.
For each grant, identify:
- The number of vested and unvested options
- Your strike price
- The grant date
- The expiration date
- Your post-termination exercise period
- The company's most recent 409A valuation
You should also review your vesting schedule. Unvested options will generally be forfeited when your employment ends unless your documents or separation agreement say otherwise.
If you have flexibility around your departure date, you don't want to unknowingly leave the company a few days before a large portion of your options vest.
What happens to your vested ISOs?
Vested options are not shares yet. They give you the right to purchase shares at your strike price.
Your company's plan determines how long that right remains available after you leave. Some companies give employees three months. Others may provide a shorter or longer period.
However, there is also a separate tax deadline to understand. To maintain ISO tax treatment, you generally must exercise within three months after your employment ends. If the company allows you to exercise later, the options may remain available, but an exercise outside that three-month window will generally be treated as a nonqualified stock option exercise for tax purposes.
That distinction matters because ISOs and NSOs are taxed differently.
Why ISO tax treatment matters
Exercising an ISO generally does not create regular taxable income at the time of exercise. However, the difference between the stock's fair market value and your strike price, known as the spread, can create alternative minimum tax, or AMT.
For example, assume you exercise 20,000 options with a $2 strike price when the current fair market value is $10. You would pay $40,000 to exercise the options. The $160,000 spread could then be included in your AMT calculation, even though you did not receive any cash and may not be able to sell the shares.
This is how someone can end up paying a large exercise cost and a large tax bill for private company stock that is still illiquid.
If you eventually sell the shares after satisfying the required holding periods, the appreciation may qualify for more favorable long-term capital gains treatment. Generally, that means holding the shares for more than one year after exercise and more than two years after the original grant date.
If you sell earlier, it is generally considered a disqualifying disposition, and at least part of the gain may be taxed as ordinary income.
Should you exercise?
This is first and foremost an investment decision. You are choosing whether to put more of your own money into the company you are leaving. That decision shouldn't be made only because the options could receive favorable tax treatment.
You need to ask:
- How much cash will the exercise require?
- How much AMT could it create?
- How much of your net worth would be tied to this company?
- How likely is a future IPO, acquisition or tender offer?
- How long could you realistically wait for liquidity?
- What happens if the company's value declines?
- How much cash would you have left after exercising and paying the potential taxes?
The company's latest 409A valuation can help you estimate the taxable spread, but it is not a guarantee of what the shares are currently worth or what someone would pay for them.
You may also want to look at the company's most recent financing round, previous tender offers, financial outlook and any transfer restrictions on the shares.
If the current fair market value is below your strike price, the options are considered underwater. You would be paying more for the shares than their current estimated value. Exercising may still be your only opportunity to participate in future growth, but you need to have a strong reason for taking that risk.
It doesn't have to be all or nothing
One of the most overlooked strategies is exercising only a portion of your options.
A partial exercise may allow you to:
- Preserve more of your cash
- Limit your potential AMT exposure
- Maintain some future upside
- Avoid putting too much of your net worth into one private company
You could prioritize grants with the lowest strike price or exercise only enough shares to stay within a specific tax or AMT threshold.
The right answer may be exercising everything, exercising a portion or walking away entirely. The goal is to make that decision intentionally rather than letting the deadline make it for you.
Review the company's rights after exercise
Your grant documents may also contain a company repurchase right, right of first refusal or other restrictions on selling or transferring your shares.
These provisions do not necessarily mean the company will buy your shares when you leave. They explain what rights the company has if you attempt to sell, transfer or otherwise dispose of them.
The price and terms can vary, so this is something you should understand before spending the money to exercise.
Keep your own records
Before leaving, download your grant documents, exercise confirmations, 409A information and transaction history. Update the equity platform with your personal email address and current mailing address.
If you exercise ISOs, keep your Form 3921 and track both your regular tax basis and your AMT basis. Those numbers may be different, and you could need them years later when the shares are eventually sold.
Don't assume you will always have easy access to the company portal or someone in HR who can recreate the information for you.
Leaving a company with ISOs can create an opportunity, but it can also force you to make a major investment and tax decision within a short period. The earlier you review the numbers, the more control you'll have over the outcome.
