Equity 101 Part 3: How stock options are taxed
Startup Codex

This three parts post features the basics of startup stock options from the employee's point of view.

It covers a number of topics: the different types of stock options, the stock option agreement, the vesting schedule, the employee departure, the strike price, the valuation, the dilution, and the tax treatment.

A very good starting point for any employee who might benefit from stock options when joining a startup.

Read Part 1 here

Read Part 2 here

You’ll pay capital gains tax on any increase between the stock price when you sell and the stock price when you exercised. In this example, you’d pay capital gains tax on $5 per share (the $10 sale price minus $5, which was the price of the stock when you exercised). Because you own the stock at this point, any gain you make when you sell is a profit from selling the asset.

The ordinary income tax rate is currently almost double the capital gains tax rate, so optimizing your exercise strategy to maximize the benefits of long term capital gains tax treatment will result in lower tax liabilities. In other words, the smaller the gap between your strike price and the stock price when you exercise, the more you could benefit from capital gain tax treatment.