📌 Educational Resource Disclaimer
This glossary provides general explanations of common equity terms. These definitions and examples are for educational purposes only and do not constitute legal, financial, or tax advice.
Equity structures vary significantly between companies, and your specific situation may have unique terms and conditions. For guidance on how these concepts apply to your individual situation, please consult with a qualified legal, financial, or tax professional.
AMT (Alternative Minimum Tax)
A parallel tax system that can create tax bills when exercising ISOs even though you haven’t sold shares or received cash.
How AMT works:
Exercise ISOs: No regular tax, but spread is an AMT item
AMT calculation includes this spread
May owe AMT even with no cash received
Get AMT credit in future years (but might not help for years)
Example (AMT disaster scenario):
Exercise 100,000 ISOs at $1.00 strike
Current FMV: $10/share (per 409A)
Spread: $900,000
AMT rate: ~28%
AMT bill: ~$252,000 (due next April)
You haven’t sold shares: No cash to pay tax
Stock later becomes worthless: You still owe the tax
Why it matters: AMT is the biggest gotcha with ISOs. Many people have been bankrupted by AMT bills on stock that later became worthless.
Capital Gains Tax
Tax on profits from selling assets like stock. Rates depend on how long you held the asset.
Long-term capital gains (held >1 year):
Federal: 0%, 15%, or 20% depending on income
Much lower than ordinary income tax rates
Short-term capital gains (held ≤1 year):
Taxed as ordinary income
Same rates as salary (up to 37% federal + state)
Example:
Buy shares for $10,000
Sell for $500,000 after 2 years
Profit: $490,000
Tax: Long-term capital gains (~20% federal) = ~$98,000
Why it matters: Holding shares for over a year dramatically reduces your tax bill. For ISOs, you need both 1 year after exercise AND 2 years after grant to get long-term treatment.
Form 3921
An IRS form that companies must provide to employees who exercise ISOs, reporting the exercise for tax purposes.
Information on Form 3921:
Date option granted
Date option exercised
Fair Market Value (FMV) at exercise
Number of shares
Strike price
Why it matters: You need Form 3921 to file your taxes properly if you exercised ISOs. It helps you calculate AMT and eventual gains when you sell.
Ordinary Income Tax
Tax on compensation and short-term gains, taxed at your regular income tax rate (up to 37% federal + state).
Triggers for equity:
NSO exercise: Spread taxed as ordinary income
RSU vesting: Value taxed as ordinary income
ISO disqualifying disposition: Spread taxed as ordinary income
Why it matters: Ordinary income tax rates are much higher than capital gains rates. Structuring equity to be taxed as capital gains can save 15-20%.
Rule 701
SEC regulation that allows private companies to issue equity compensation to employees without full securities registration requirements.
Key limits:
Can issue up to the greater of:
$1M in 12 months, or
15% of total assets, or
15% of outstanding securities
💡Anything over these limits: Must provide additional disclosure.
Why it matters: Rule 701 makes it easier for startups to grant equity without expensive compliance. Most startups stay under these limits.