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Subject:   Early exercise on ISO, then company bankrupt
Date:   Tue, 18 Dec 2001
From:   SJLee

I worked at an Internet startup, and did an early exercise on part of my incentive stock options in 2000, electing 83(b). Then the company went bankrupt this year (2001) and I got let go. Only a part of my ISOs were vested at the time of my early exercise, and it was still not fully vested when the company went bankrupt. After all, it was an early exercise. In this case, can I claim some form of a deduction on my early exercise cost on my ISO? What kind of tax benefit can I use related with this loss? It seems like the "worthless investment" category should apply in this case, and I should be able to deduct the loss as a long term capital loss.

Thanks much!
sjlee

Answer

Date:   26 Dec 2001

Hello SJLee,

Yes, it appears your stock may be worthless. However, if the company is not terminated by the end of the year, for example, if its in Chapter 11 bankruptcy, you can’t take your worthless stock loss, yet.

See if you can arrange a private sale of the stock with your broker (not a relative) for $1.

If you held the stock more than one year after exercise, you should report a long-term capital loss.

If you haven’t met the holding period requirements, the ordinary income limitation may apply for regular tax purposes, but you may have a long-term loss for alternative minimum tax reporting, subject to the $3,000 capital loss limitation.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.