Navigating IPOs and Incentive Stock Options (ISOs)

ISOs in IPO

If your company is preparing for an Initial Public Offering (IPO), it’s an exciting time—especially if you hold Incentive Stock Options (ISOs). But before you rush to exercise those options, there are crucial considerations that could make or break your financial strategy.

What are Incentive Stock Options (ISOs)?

Incentive Stock Options are a type of employee stock option that comes with potential tax benefits, making them an attractive component of your compensation. They allow you to buy company stock at a set “exercise price,” typically the market value at the time of the grant. The options become exercisable according to a vesting schedule, which usually spans four years, and they come with an expiration date by which you must take action.

If you don’t exercise your ISOs by the expiration date, they expire and are worthless. Generally, you have up to 10 years if you’re still employed, but if you’ve left the company, this window can shrink to as little as 90 days or sooner if your company is nearing an IPO. 

Dig out that options agreement to confirm how your ISOs are treated with an IPO!  Some sample language can be found in the Reddit stock agreement.

ISOs, if managed properly, may only be taxed at the more favorable long-term capital gains rate. However, you must hold your shares for at least one year after exercising and two years after the grant date. Meeting these requirements means the sale of your ISOs will qualify for long-term capital gains tax, which could result in a significant tax savings compared to ordinary income tax rates.

What are Non-Qualified Stock Options (NQSOs)?

Before diving into the IPO conversation, let’s quickly break down how ISOs differ from Non-Qualified Stock Options (NQSOs).

NQSOs are generally given early on in a startup’s trajectory, to advisors, or as additional incentives as employees reach the ISO limit.

With NQSOs, you’ll pay taxes at the time of exercise, recognizing ordinary income on the difference between the stock’s value and your exercise price. This is a big difference from ISOs, which may be eligible for long term capital gains treatment at their sale.

However, ISOs come with limitations. You can only vest up to $100,000 in value of ISOs in a given calendar year to enjoy this tax benefit. Anything over this amount is treated as NQSOs.

Check your stock portal to see if this ‘ISO/NQSO split’ is occurring over your vesting period.  Often, this will happen more in the later years of vesting as the stock value quickly rises.

— Do you learn better from audio or video?  Check out this conversation on our YouTube video about this topic HERE —

Be Aware of the AMT Trap

Even though ISOs offer appealing tax treatment, they come with a catch: the Alternative Minimum Tax (AMT). AMT is a parallel tax system that kicks in when certain “preference items,” like ISOs, push your tax liability higher.

The AMT system has only two tax rates, 26% and 28%, and a larger exemption rate (as of 2024).  You only see AMT on your tax return if your AMT tax due is larger than your regular tax due.   

When you exercise your ISOs, the difference between the stock’s current value and your exercise price (known as the bargain element) is included in your AMT calculation. If you’re exercising a small number of options, you might not notice the impact. However, if you exercise a large number of options, the AMT can take a big bite out of your finances.

For example, we’ve seen AMT taxes due soar to $250,000 or more on ISO larger exercises. So, before you exercise, make sure you have a tax professional in your corner to help you navigate the complexities.

The IPO Opportunity: Timing Your ISO Exercise

So, why exercise ISOs ahead of an IPO?

An IPO creates a liquid market for your company’s stock. By exercising your ISOs pre-IPO, you could lock in a lower stock price and start the clock on your long-term capital gains tax treatment. 

However, the stock price could fluctuate dramatically after the IPO, making this a risky move if you expect an IPO soon. NASDAQ research from April 2021 showed that while 34% of IPOs gained over 10% in their first year, more than 50% lost 10% or more.

If your company is eyeing an IPO within the next 18-24 months, now might be a good time to assess how much cash you can afford to put at risk. Exercising a portion of your ISOs each year could help you spread out the AMT cost and mitigate some risk if the IPO is delayed.  We like to call this ‘laddering’ our exercises (and potential sales) to minimize taxes across the board.

Not sure if an IPO is in your future?  Check out our blog post on when to consider exercising stock options as a pre-IPO company here.

Case Study: Jane’s ISO Strategy

Let’s consider a real-world example. Jane, a long-term employee at a tech startup, is weighing her options ahead of the company’s IPO.

Jane received two ISO grants:

  1. 10,000 shares at $0.10 per share, which she exercised early with an 83(b) election.
  2. 10,000 shares at $3.00 per share, which she hasn’t yet exercised due to the cost to acquire them ($30,000).

With her company’s IPO on the horizon, Jane and her advisor reviewed her financial situation to determine how much cash she could comfortably invest in exercising her ISOs. 

After accounting for her emergency savings and other expenses, she decided to allocate $10,000 toward her stock options.

Together, they calculated the potential AMT liability based on the current 409A valuation and the expected IPO price. By exercising some ISOs before the IPO this year and planning to sell RSUs after the IPO, they managed the risk while maximizing the tax benefits.

The Takeaway: Make an Informed Decision

Exercising ISOs ahead of an IPO can be a smart move, but it requires careful planning. Be sure to evaluate your financial situation, risk tolerance, and tax implications before making any decisions. Working with a financial advisor and tax professional can help ensure you navigate this complex process successfully.

If you’re considering exercising your ISOs before an IPO, weigh the risks, rewards, and your financial goals carefully. With the right strategy, you can maximize your wealth while minimizing unnecessary taxes.

Looking for a Financial Partner in your IPO journey?  Schedule a call with us to learn more.

The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

 

What is the maximum 529 contribution? Should I fully fund it?

What is the maximum 529 contribution? Should I fully fund it?

What is the maximum 529 contribution?  This question can actually mean two separate things.

  • What is the annual maximum contribution I can make before gift taxes apply?
  • What is the maximum contribution I can make in total to my 529 plan?
  • What should I fund for a 529 plan for my child(ren)?
Let’s break these questions down…
 

Annual Maximum 529 Contribution

When you hear ‘maximum 529 plan contribution’, this usually refers to the annual gift tax exclusion.  A 529 contribution is considered a gift to another person (i.e. your child).  Gifts to other individuals above a certain threshold are taxable events in the United States.
 
For the 2024 tax year, gift taxes may apply for gifts above $18,000 per individual (or $36,000 for married couples filing jointly).  
 
This applies to 529 contributions as well.  You can contribute up to $18,000 each year, per child, without having to pay gift tax as of 2024.  This amount can change annually based on inflation.
 
On the flip side, 529 contributions may earn you a tax deduction or tax credit in certain states.  Generally, to obtain the tax deduction or credit, you must use the 529 plan designated by the state.  The benefit can range from $80 to $1,200+ in a reduction of state taxes.  Find out whether your state offers a benefit HERE.
 
If you are willing to file a Gift Tax Return (Form 709), you can stretch this contribution even further in a year.  
 

The 5-Year Election for 529 Contributions

If you are going through an IPO or a large liquidation event in one year, you may decide to make a ‘5 year election’ to superfund your 529 plan.  
 
This means you can contribute up to $90,000 per individual (or $180,000 for married couples filing jointly) to a 529 plan in a year.  The catch is you cannot make further contributions to the 529 plan in the following 4 years and you must file a Gift Tax Return.
 
The benefit of making the 5 year election is mostly around time.   You fund the 529 plan now and allow more time for the investments to grow.  This can be a great way to ‘set it and forget it’.
 

Total Maximum Contribution to a 529 Plan

So if I can technically make a 529 plan contribution each year up to $36,000 for married filing jointly couples and I start the day my child is born, I could actually put in $648,000 by the time they graduate from high school???
 
Nope!
 
529 plan total contribution limits range from $269,000 to $570,000, depending on the state.   This limit really boils down to what the state believes is a good estimate for attending school.  North Dakota believes this to be $269,000 while Utah says this is $560,000.  
 
Where you open your 529 plan should account for tax benefits, plan costs, investment choices, and how much you plan to contribute to it.
 

Funding a 529 plan for your child

Whether or not you should fund your 529 account to the max depends on a number of factors, including your income, your savings goals, and your child’s age. Here are some things to consider:
  • Your income: If you are in a low tax bracket and expect to stay there, you may be eligible for financial aid through the FAFSA process.  Get to know the components of how your ‘expected family contribution’ (EFC) is calculated to know how much would be expected of you in today’s dollars.  If you are in a higher tax bracket or you’ve accumulated $2 million+ in investments, you will need to pay for the majority of your child’s college expenses.
  • Your savings goals: Prioritize retirement savings and high-interest rate debt first. Put your own oxygen mask on first before helping a child!  Then, if you feel comfortable you are on track financially, then consider what 529 contributions you can make. 
  • Your child’s age: If your child is young, you have more time to allow the 529 contribution to grow. This may mean a few years of maximum annual contributions will go a long way.  However, if your child is older, you may need to contribute each year in order to save enough money.  If your child is already in high school, you may want to consider whether a 529 plan is still the best option for you.
  • Your child’s college plans: If your child is likely to attend a state school, you may not need to save as much as if they are planning to attend a private school. This is because state schools are typically less expensive than private schools.

The 529 conundrum

The best time to fund a 529 plan is when your child is still under age 3 for the largest potential growth… but you should only fund it based on what kind of college you expect them to attend…  What does that mean I should do? 
Ultimately, the decision of how much to contribute to your 529 account is a personal one. There is no right or wrong answer. 
 
At SeedSafe Financial, we make sure our clients are on track financially.  Then, we balance retirement dreams, expense expectations, and the desire to set their family up for success.   This means each family may have a different plan:
  • some may contribute $36,000 for a few years and stop,
  • others may contribute $8,000 a year until high school, 
  • and a few will make a 5 year election and superfund a 529 plan to the max
The important piece of this is to know what you can afford to do that doesn’t put your own long term safety at risk.
 

Why should I consider contributing the total maximum to a 529 plan?

If you are in a good place financially, making $1M+ a year, or have a net worth of $10M+, there is a case to consider contributing the total maximum allowed.
 
It’s called the ‘multigenerational’ 529 plan strategy (or Dynasty 529 plan).
 
This is where you use a single 529 plan account to support education for multiple individuals.  You start by creating the plan for your child and contribute up to the maximum $560,000 over the first 15 years.  
 
Then, you utilize the funds for college expenses for your child (as intended).  However, there will most likely be quite a bit left as the investments continue to grow.  What happens to this ‘leftover’ money?
 
The IRS allows for a beneficiary of a 529 plan to be changed to “a member of the family” of the beneficiary.  This means you could change the beneficiary from your child to your grandchild in the future.
 
The goal is for the investments to continue to grow over long periods of time – allowing the gains to compound.  Then,  when each future generation goes to college, they are able to use those gains and continue the line of funding.  This feels like magic.
 
And with all magic, the IRS wants to know it isn’t being abused.  Changing the beneficiary may still trigger the gift tax rules (remember those from the beginning of the article?).  However, another 5-year election or part of the lifetime gift exclusion could be used to help offset this tax cost.  (Work with your tax advisor to make sure this is correctly reported).
 

That is a lot to think about.

Remember how I said there is no right or wrong answer?  Consider your individual circumstances and make the decision that is best for you and your family.
 
Some tips we suggest for all 529 plans:
  • Start early: The sooner you start saving, the more time your money has to grow in the account. Even if you can only contribute a small amount each month, it will add up over time.
  • Set up a regular contribution schedule: One of the best ways to save for college is to set up a regular contribution schedule. This will help you stay on track and reach your savings goal.  You may decide to use ESPP funds on a quarterly basis, RSUs as they vest, or from your paycheck.  Whatever method you choose, make it consistent.
  • Take advantage of gifts:   Let family know you’ve set up the 529 plan and send them a gift link.   You may be pleasantly surprised at who all wants to help fund your child’s education 🙂
  • Get professional advice: If you are not sure how much to contribute or which type of 529 plan is right for you, be sure to get professional advice from a financial advisor.  
If you don’t have a financial advisor, consider scheduling some time to chat with us.
 
Did you enjoy this article and are looking for other ways to set your child up for financial success?  Check out our blog post HERE.
 
The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.
 

 

Is a Mega Backdoor Roth Strategy Worth it?

Is a Mega Backdoor Roth Strategy Worth it?

If you’ve joined the tech industry in the last 5 years, you’ve seen a huge adoption of the ‘after-tax 401(k)’.  The after-tax 401(k) is an employee benefit that allows you to put more money away for retirement and implement the Mega Backdoor Roth strategy.  We see this often available for our clients at larger tech companies like Amazon, Google, and Microsoft.  

There are many articles on what a Mega Backdoor Roth is, but fewer that explain why you should do it and how to do it.

If you’re considering whether this strategy is worth it for you, below is a detailed look at what it is, the benefits, and potential pitfalls.

What is a Mega Backdoor Roth IRA?

First, a quick breakdown of how the Mega Backdoor Roth strategy works. Essentially, it’s a way to convert after-tax 401(k) contributions into a Roth IRA. Here’s how it works:

  1. In your 401(k) portal you will have the option to contribute pre-tax, Roth, and/or after-tax.  Contributions to pre-tax or Roth are the usual ‘employee contribution’ we’ve seen available in 401(k) plans for a long time.  For these contributions, the maximum total amount you can add to it is $23,000 in 2024 (or $30,500 if you are age 50 or older).  An additional benefit is the after-tax 401(k) contribution.
  2. After-Tax Contributions: The limit on after-tax 401(k) contributions is up to the overall 401(k) limit of $69,000 (or $76,500 if you’re 50 or older).   
  3. Maximum After-Tax Contributions:  This varies from employer to employer.  The overall 401(k) limit applies to how much you can contribute.  The overall limit includes your regular employee contribution, your employer contribution, and any after-tax 401(k) contribution.  This means how much your employer contributes may change the total amount you can set aside in the after-tax 401(k).
  4. In-Plan Roth Conversion or In-Service Withdrawal: These after-tax contributions can be converted to a Roth 401(k) or rolled over to a Roth IRA.  Once rolled to a Roth and invested, they can grow tax-free.  However, this is usually an election you need to make within your 401(k) portal.   I’ve seen this missed by employees at Google, Amazon, etc where they thought selecting the after-tax 401(k) option was all they needed to do.  Don’t forget to click that ‘Convert to Roth’  button 🙂

Benefits of a Mega Backdoor Roth IRA

  • Tax-Free Growth: Once the funds are converted from the After-Tax 401(k) to a Roth account, they grow tax-free. This can add significant tax savings, especially if you have a long investment horizon before you take distributions.
  • High Contribution Limits: The ability to contribute up to the overall 401(k) limit generally means you can put $40,000+ towards the strategy.  This is far beyond the regular Roth IRA limits of $7,000 (or $8,000 if you’re 50 or older).
  • Flexibility in Withdrawals: Your Roth IRA does not have a ‘required minimum distribution’ (RMD) during your life.   This means more flexibility in retirement planning.
  • Inheritance Planning:  With the new inherited IRA rules post-2020, all assets in the Roth IRA must be distributed within 10 years following the original owner’s death (or 5 years for beneficiaries that are trusts and other situations).   This means if you have a large IRA balance at death, then your beneficiary may recognize more income over those 10 years.  This can result in a higher tax bill.  If you leave a large Roth IRA balance at death, then this new rule won’t impact taxes since distributions are tax-free.  
  • Tax Diversification: A mix of tax-deferred, taxable, and tax-free retirement accounts can provide greater flexibility around taxes in retirement. 
  • High Income Earners: The Roth IRA income limit is $240,000 for married joint filers (or $161,000 for single taxpayers).  This strategy gives you an opportunity to still put money towards Roth accounts.

Considerations and Potential Drawbacks

While the mega backdoor Roth IRA has considerable advantages, it’s not without potential downsides:

  • Cash Flow:  Don’t put the cart before the horse – if you don’t have the buffer in cash flow to enact this strategy things can go sideways fast.  It’s not worth racking up credit card debt to be doing ‘all the cool hacks’.  Get your spending plan right first.
  • Savings Strategy:  Don’t forget to prioritize 401(k) employee contributions and HSA contributions first.  (Interested in why we say look at HSAs first?  Find out more here.) If you are healthy and have excess cash flow, there are even greater benefits to looking at these first.  There is certainly a priority list in how to consider your employee benefits 
  • Complexity: You need to make sure you track conversions on your tax return through the years.  Maintaining IRA and Roth IRA basis in your workpapers may be vital if changes in the tax code occur.  If any gains happen between the after-tax 401(k) contribution and the conversion to the Roth IRA, you will receive a Form 1099-R to add to your tax return.
  • Immediate Tax Impact: The conversion of after-tax contributions to a Roth account can have immediate tax consequences on any earnings from the after-tax contributions.  This is why clicking the button to allow in-plan conversions is vital!

Is It Worth It?

The decision to use a mega backdoor Roth IRA strategy depends on several factors:

  • Your Financial Goals: If your goal is to maximize tax-free growth and you have the means to contribute significant amounts to your retirement savings, this strategy can be highly beneficial.
  • Early Retirement:  If your goal is to get out of the 9-to-5 game by age 50 or you are still working on financial flexibility, this may not be the time to lean in.   Make sure you are focusing on the right mix of investment vehicles that will get you there.  Locking up every-last-dollar into retirement accounts may not be for you.
  • Plan Features: This strategy works best when the after-tax 401(k) allows for in-service withdrawals to minimize the tax bite.
  • Current and Future Tax Brackets: Consider your current tax bracket versus your expected tax bracket in retirement. If you expect to be in a higher tax bracket later, paying taxes now on conversions may be a good idea.  For our California clients, many need a $5 to $10 million investment portfolio to fully lean into financial independence.  This means their future tax bracket on investment income will have a huge impact.
  • Comfort with Complexity: This strategy requires a solid understanding of tax rules and reporting on your tax return. If you’re comfortable with these aspects or have a financial advisor to guide you, it can be a worthwhile endeavor.  

Conclusion

The mega backdoor Roth IRA is a powerful tool for those looking to significantly boost their retirement savings and benefit from tax-free growth. However, it’s not suitable for everyone. 

  1. Make sure you know how to enact the full strategy
  2. Review your finances to know where it fits in your spending/saving plan and long term goals
  3. Consider bringing in an expert to help you decide what will help you reach financial flexibility faster and give you a roadmap to financial independence

If you are still on the hunt for the right financial advisor for you, schedule some time with us to see how we can help grow your wealth.  Find out more about our team here.

The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

 

Should I use a Donor Advised Fund for charitable giving?

Donor Advised Fund tax benefits

During the holidays, giving is on the mind. Who should you give charitably to? How much should you give? What is the best way to give?

If you want a tax efficient way to set up long term giving, a Donor Advised Fund (‘DAF’) may be for you.

How do Donor Advised Funds work?

Donor Advised Funds (‘DAFs’) are a way to donate cash, stock, etc now to support charitable causes later. A Donor-Advised Fund is an account that you can make a contribution to and qualify for a tax-deductible charitable donation. Once you contribute the funds, you cannot take money out of the account for non-charitable purposes later.

Donor Advised Funds stay in the account until you are ready to give funds to a qualified public charity (even years later). However, Donor Advised Funds aren’t for everyone.

When should you use a donor-advised fund?

For our tech professional clients, this may look like donating company stock they’ve held for a long time to a Donor Advised Fund. Or setting up a Donor Advised Fund at a company exit to help with long term giving. This sets them up for the tax benefits of a Donor Advised Fund that then grows tax free for supporting future charitable endeavors.

The top reasons to use a Donor Advised Fund are:

  • The tax benefits in donating highly-appreciated stock
  • The strategy of ‘bunching’ charitable contributions for a tax deduction
  • Planning during a company exit (Merger, acquisition, or IPO)
  • Investing the funds to grow tax-free for future charitable giving

What are the tax benefits of a Donor Advised Fund?

The tax benefits of a DAF are threefold:
1. You can give cash, stock, or other complex assets (land, etc). You can transfer over low cost basis assets without paying the tax on unrealized capital gains. If you had to sell the stock or asset to make a donation, you’d pay taxes and potentially have less to give in cash. With a stock or asset transfer, you give the fair market value of the contribution without additional tax consequences.

2. You get an immediate year charitable deduction for your contribution to a DAF. This means you can take your higher income years to make a larger DAF contribution that can be used over many years.

3. You have the opportunity to invest the donation in stock investments to grow tax-free until you are ready to give funds to a charity. Since the funds are already in the DAF account, any stock sales won’t count against your personal tax return.

Bunching charitable contributions for a tax deduction

Do you give $10,000 a year towards charities and still take the standard deduction on your tax return? If you are able to contribute more to a DAF every few years, you may be eligible for a bigger tax deduction for the year.

There is no contribution limit on how much you may donate to a Donor Advised Fund..

This can help you plan your charitable contributions a bit more beyond giving to charities through the year. You could decide to contribute two year’s worth of charitable funds to make sure each dollar counts towards a deduction on your tax return.

Matching a high income year with a larger DAF contribution

Another strategy is to make a contribution the same year as your company exit. If you have stock compensation at a smaller tech company and own shares, this may me a good time for a DAF. When income is very high, a charitable contribution to a Donor Advised Fund could set up your giving over the rest of a lifetime. At SeedSafe Financial, we understand your charitable giving goals, any flexibility needed for the funds, and make a discounted cash flow analysis to know what amount may work well for a contribution.

You may reach a level where you are over the threshold for a current year’s itemized deduction on your tax return. Any charitable contribution more than the limit will carry forward for up to 5 years. For 2023, the general limit on charitable contributions to DAFs is 50% of adjusted gross income.

Ease to open, low cost to grow, and streamline your giving

Donor Advised Funds are as quick to open as other brokerage investment accounts. You can be up and running within minutes on sites like Schwab Charitable, Fidelity Charitable, and CharityVest.

You can choose to invest all or part of your funds in the DAF account. Your contribution should be invested based on your charitable giving goals. Are you hoping to use this account primarily for giving in retirement, over your lifespan, or in the next few years? The risk you may be comfortable taking in each of those situations could differ. Growth from investing the funds in the account will be tax-free.

Most Donor Advised Funds offer a low cost mix of ETFs or model portfolios to choose from. This helps streamline your investment strategy while you decide how you want to give the funds over time.

 

How does it work to send funds to charities from the Donor Advised Fund?

Giving funds to a charity through the Donor Advised Fund is called a ‘grant’. Qualified grants are generally to public 501(c)(3) charities. The IRS has a search tool for you to review what organizations meet this requirement on their website (HERE). The DAF providers may differ in the process of distributions to charities and may have a minimum grant size requirement. When reviewing DAF providers, it is important to know how and when you want to use the funds so you can pick the best option for you.

In the end, a Donor Advised Fund works best for higher-income earners or those with large gains sitting in their taxable investments. How much to contribute is based on what your hopes are for charitable giving. We recommend reviewing this strategy with a tax professional or financial planner. Especially if you are considering donating exercised incentive stock options.

Looking for a financial planner and CPA? Schedule some time with us to chat and learn more about our services.

The above discussion is for informational purposes only. Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

Should I choose the HDHP or PPO from my company’s benefits?

HDHP or PPO

Benefits enrollment season is upon us again and we often review if a HDHP or PPO makes more sense…it depends!  

What health insurance is best for you depends on a few things: 

  • Your current health and how often you see a doctor, 
  • Whether you have extra cash to pay for medical costs, and 
  • If you feel you can emotionally take that risk

What are the terms to know when evaluating a HDHP vs PPO?

PPO – a ‘preferred provider organization’ gives you more in-network options for providers (doctors, medical offices, etc) than other plans may have.  You also do not need a referral from your primary doctor for most specialists.

HDHP – a ‘high deductible health plan’ can actually be a PPO – the main difference is that it meets certain IRS requirements to qualify for adding an HSA ‘health savings account’.  These plans typically have lower premiums but higher out-of-pocket costs.

Deductible – The cash you put towards doctors visits, prescriptions, etc before your health insurance pays the provider in full.  

For PPOs, there is often a per visit and per medication amount you pay  (‘copay’) up to the total deductible amount

For HDHPs, you generally pay the full cost of visits, care, and prescriptions until you reach the total deductible

Out-of-pocket maximum – the amount you pay before the health insurance company covers additional needs. Each insurance plan is different. The out-of-pocket amount is higher than the deductible and includes additional prescription payments, hospital visits, etc up to a certain dollar amount.

Premiums – your contribution from your paychecks to your health insurance plan

In-network vs out-of-network – In-network services are at a negotiated price with the health insurance plan. Out-of-network providers do not have a contract with the health insurance plan.  Your out-of-network maximum cash out-of-pocket amount is generally much higher.

Is it better to have a PPO or HDHP?

This depends on your plans available. Review your summary of benefits in your enrollment package to understand insurer choices, premium cost, deductible, and out-of-pocket maximum.   

Then, review each type of care listed to understand how the PPO or HDHP may cover each of those needs. Often you will see a lower copay and deductible for PPO plans but a higher premium.

The basic trade off is:  a higher premium means lower costs for each care need.  A lower premium means a higher out-of-pocket contribution.

So why would you choose a lower premium?

One reason may be if you are in good health and rarely see a doctor.  You may choose to take the risk of not paying for health care services if you believe you won’t need many.

For higher-income earners, the reason may be to participate in the HSA ‘health savings account’.

What is a HSA ‘health savings account’?

An HSA ‘health savings account’ allows you to make pre-tax contributions to an account and make tax-free distributions from it to pay for qualified health insurance costs.  What you do not use within the year will continue to remain in the account for future use. This beneficial treatment is limited to $8,300 for a family/$4,150 for an individual in 2024. For employees over age 55, there is an additional $1,000 catch up contribution available.

For high-income earners, this may mean saving 37%+payroll taxes on contributions to an HSA account or ±$3,500 a year!  *Note, states like California may add the HSA back to taxable income. Federal, it will be a pre-tax benefit

What makes HSA accounts even more attractive is when an employer makes a contribution (free money!) or you are able to allow the HSA contributions to accumulate in the account. Most HSA accounts allow you to further invest what is in your account. This means these investments can continue to grow over time for future needs.

We know an HSA account allows tax-free distributions for qualified medical costs.  It can also grow until you reach 59 ½+, then it can also be used for retirement expenses like an IRA or 401(k).

This makes the HSA account a triple threat for high income earners:

  1. A current pre-tax contribution
  2. Ability to pay for qualified medical costs tax-free, and
  3. Grow the account with investments long term for retirement

What is an FSA ‘flexible spending account’?

An FSA is another account that allows you to make pre-tax contributions for medical expenses you may have in a given year.  This account is generally paired with the PPO and is limited to $3,050 in contributions in 2024. The downside is, if you don’t use it, you lose it!  So you may decide not to max out this account and only put in what you believe you will need for the year.  Some companies allow a grace period into the following year – but not longer than the first 3 months.

Example of a PPO vs HDHP

Annually, we do a review of our clients’ enrollment benefits to understand what is changing and review the available options. This tends to include an analysis of whether a PPO or HDHP may make more sense for them.

Let’s use the example of a family at the 35% tax bracket in income and the employee is 47 years old.  They have excess cash above their expenses each month to use towards medical expenses and maximizing a contribution to an HSA.  Their company provides a $1,000 family contribution to the HSA account.  At this point, they tend to go to the doctor around 10 times a year and need a few prescriptions as things pop up.

First, we gather information on their deductible, out-of-pocket maximum, and premiums.  Then, we talk through available health insurers and whether their current doctors would be considered in-network. If we feel pretty good about the information given, we will create a calculation to understand what the net after-tax cost of each option may be.

In this example we are looking at the tax savings and cash outlays of what are involved under each situation. The actual calculation for you may be very different, but in this example the HDHP means a current year benefit of $2,039 for the family. 

This doesn’t include any long-term growth of allowing the HSA contribution to be invested and untouched for 12+ years.

When does a HDHP not make sense?

There is still a risk that your medical care needs are greater than expected or that you need out-of-network health care. If you travel often and enjoy riskier activities, then that may mean a higher likelihood that the savings of a HDHP do not materialize for you.

It also may not make sense if you do not have the cash available to maximize the HSA and pay for your medical expenses out of pocket.

Reviewing your benefits package is about making your best assessment. You can always change your mind with the next enrollment season 🙂

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The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

 

What tax election should I make at an IPO?

Tax election at IPO

If you have double trigger RSUs and an IPO coming up, you may receive a ‘tax election’ from your company.   This tax election allows you to decide how much you want to have set aside for taxes on your vesting RSUs at the time of IPO.

For the purposes of this conversation, we will hit on why you might want to choose one tax withholding option over another.

Why do I need to make a tax election at an IPO?

Remember, tax withholding ≠ taxes due.  Tax withholding is a required high-level estimate of taxes that needs to be paid into the IRS throughout the year.  Even if it feels like you’ve paid a lot in tax withholding, you may still owe more at tax time.

Do you want a refresher on double trigger RSUs and an example of the tax breakdown? Check out our post What are Double Trigger RSUs and how are they treated?  

Should I choose to withhold 22% or 37% in Federal taxes from my IPO vesting?

It depends.  How much you withhold for taxes depends on how you want to think about your stock and what your total income for the year will be.  

Some individuals view 37% withholding as ‘leaving gains on the table’ for shares that *could have* appreciated.   Some individuals view 22% as being a big risk that they may have to sell more shares to cover a tax bill if the stock price goes down.

We encourage you to consider this using examples of what that risk might be for your own situation.

Examples of taxes at an IPO

Let’s choose two situations.  The first scenario is for Greg and the second scenario is for Alexa.  We assume that both Greg and Alexa have families and are expecting an IPO to happen at year end.  This IPO will help them each with buying their next home and getting closer to financial independence.  The biggest difference between them is that Greg started at the company as an IC and Alexa came on as a Director.  What could their taxes look like?

Example of tax withholding on RSUs at IPO

By estimating what their total income for the year will be and the taxes due, we can get an idea of what their estimated tax load (aka ‘effective tax rate’ may be).

Other considerations for estimating taxes

Some bigger pieces we are leaving out of these examples are:

If your salary is low, chances are your withholding on your salary is much lower than needed at the IPO.  Salary withholding tables were made by the IRS assuming your salary is your main income.  It matches tax withholding requirements with that income expectation.  If both spouses are working, this effect is magnified.

If you have ISOs or NQSOs to consider, the math gets way more complex.  We recommend working with your tax advisor or financial planner to create the best strategy for you.

Other sources of income may change the math as well. If you do consulting on the side, have other IPOs in the same year (yes, this has happened to our clients in the past!), or long term rentals, then you will need to up your estimate.

Now let’s see how the 22% and 37% tax withholding election could work out for them.

Examples at 22% tax withholding

This is where total estimated income and the effective tax rate matter.  Let’s break down the withholding made a bit further between salary and the RSUs vesting at an IPO.

22% tax withholding on RSUs at IPO

In this case, the difference in total income makes a huge difference in how much more they will still owe come tax time.  Greg may view the risk of $10,000 needed in cash to cover the shortfall as ‘worth the risk’ or up his withholding in case the stock price drops.  Alexa’s shortfall could be catastrophic if she isn’t ready to pay $200,000 at tax time.

What are the downsides to taking on the risk of lower tax withholding?

This comes down to what you can afford to take risk wise and what you can’t.  Greg may have $10,000+ in cash savings annually and see this as a high risk/high reward worth electing the lower 22% tax withholding for.

Alexa may not have $200,000 laying on the sidelines to pay her taxes with.  Even more importantly, what if she did??

Each IPOing employee in this situation should ask themselves: 

1. If you sell more for withholding now and it goes up, how would you feel?

2. If you don’t sell enough to cover taxes now and it goes down, how would you feel?

In Alexa’s case, how would she feel paying $200,000 in to cover taxes only to see the stock tumble?  If the answer is 🙁, then Alexa should select 37% withholding.

Another consideration is the lockup period.  Most IPOing companies have a 180 day lockup period (with some caveats).  I don’t have data on how IPOs tend to look 6 months out, but there is a great study at NASDAQ on what happens to IPOs over the long run.  Long term, the majority of IPOs do not perform well and drop below their IPO price.  This is something to consider in your risk assessment.

Examples at 37% tax withholding

What would happen in each of these scenarios at 37% withholding?  Each would end up with a refund after filing their taxes.  

37% tax withholding on RSUs at IPO

I like to think of this as selling some shares at the IPO price – because that is effectively what will happen.  🙂

Through these two examples, you now have an idea of what a 22% tax withholding rate vs 37% tax withholding rate might mean for you.  The important thing is that you know what to expect – uncertainty and big tax bill surprises can take the fun out of your Company’s IPO.  

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The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

What are Double Trigger RSUs and how are they treated?

double trigger rsus

Double trigger RSUs are a popular type of stock compensation leading up to an IPO.  They are better for the employer – who doesn’t need to recognize stock expenses until IPO.  They are less mental energy for the employee – who doesn’t have to pay taxes or make sell decisions until IPO.  

What is the difference between single-trigger and double trigger RSUs?

RSUs are Restricted Stock Units your company gives you as an incentive to build company value.   
 
The ‘single trigger’ versus ‘double trigger’ translates to 1 requirement or 2 requirements to ‘trigger’ vesting.  
 
Single trigger vesting is generally based on ratable vesting over a period of time during employment (‘Service Vesting’).  Double trigger RSUs include another vesting component.
 
If you have single trigger RSUs, check out our RSUs Basics blog post.
 

How does double trigger vesting work?

Double trigger RSUs are service vested (first trigger) and release at an IPO/exit  (second trigger).   When one unit meets both of these triggers, it vests to you and you receive one share of company stock.
 
Double trigger RSUs are different from stock options because there is no ‘option to buy’ the stock.  Instead of having an option, your RSU immediately vests into stock when both triggers are met.  At that point, you make the decision when to sell it.
 

What happens to a double trigger RSU at an IPO?

Double trigger RSUs are generally taxable as ordinary income (like your salary) at IPO.  
 
The income and tax withheld (federal and state) at vest will be on your IRS Form W-2 from the company in the vesting year.
 
Since you pay income taxes on the vesting amount, this becomes your new ‘cost basis’.  Each Custodian accounts for this a little differently on tax forms.   Some adjust it on the 1099 and others provide a supplemental form that shows the true gain/loss on sales.
 
This is why maintaining your trade confirmations or statements from the custodian (i.e. Schwab, Shareworks, etc) is important.  
 
If you miss those details on the supplemental form, then you could be paying doubled up taxes.  If you know about how much vested, then you will know whether the 1099 looks right.  
 

Does my company pay my taxes on the double trigger RSUs at vest?

Some employees are surprised when 40%+ of their vested shares sell for tax withholding purposes.  Others end up with a surprise when they owe the IRS money on their tax return!  
 
This happens because tax withholding ≠ tax due.  Stock compensation is withheld at only 22% federally on the first $1M in stock/bonuses.  This may differ from your actual effective tax rate in the end.  If your effective tax rate is higher than 22%, be sure to set aside a higher percentage to help fund the tax bill.  
 
At a state level, this can vary.  Some states have a flat income tax, while other states (like California) have a different  withholding rate from the tax rate. This means you may owe more taxes at a state level as well.
 

What is an example of taxes on a double trigger RSU?

Here’s an example of what it might look like.

Example of taxes on double trigger RSUs 
40% of the shares sold for tax purposes, but this may not be enough withheld for Federal taxes if the individual makes over $1,000,000 in total. They may need to be ready to pay 10% or more ($100,000+) in taxes towards these shares on their tax return too.
 

When double trigger RSUs vest, you will want to make sure you account for this as you decide what to do with the shares.

Do I owe taxes on my double trigger RSUs if I hold onto them after the IPO?

If you decide to hold onto your shares after vesting, your stock will be like other stock investments.   
 
If you decide to hold onto them, your holding period will start the day the shares vested to you and capital gains/losses will apply based on that date.
 
As a reminder: since you already paid ordinary income taxes on the value at vesting, your basis will be the fair market value from your vest date.  
 

Do I owe taxes on my double trigger RSUs if I sell them after IPO?

After vesting, the stock is treated like any other stock investment.  Capital gains/losses apply.
 
The type of capital gains tax is based on the length of time you hold the shares from the vesting date as well.  Long term capital gains rates apply when you hold the stock more than one year from the vesting date.
 
After vesting, the swings in the stock price will count towards capital gains /losses on your tax return.  This means you may owe more taxes on sale (if the stock appreciates beyond the vest value).  If the stock loses value, you will not be able to offset the vesting income with the losses.  Those losses are considered capital losses that can only offset other capital gains.
 
Example:  Using the above example, your basis in the shares would be $1,000,000.  If you sold the shares for $1,500,000 at a later date, you would be subject to capital gains tax on $500,000.   
 
Depending on the time held, you would pay short term or long term capital gains tax (and the net investment income tax above a certain income level).
 
If you hold the stock and the price drops below the value at vesting, you may recognize a capital loss.  You may be able to use those losses to offset capital gains from your company stock.  Losses greater than current capital gains offset income up to $3,000 a year.  Any unused losses carry forward to future years.  Unfortunately, you can not claim the taxes paid at vesting back.  This is one risk of many encountered in holding your company stock long term.
 
Following with the above example, if your basis in the shares is $1,000,000 and you sold the shares for $750,000 at a later date, you would have a loss of $250,000.  Depending on other investment sales and capital gain distributions, you may be able to offset some of this loss or not.  If you do not have any, you would only be able to claim $3,000 of capital gains loss on your tax return.  The remaining $247,000 loss would carry forward to future tax returns.
 
This is where having an investment manager who can help you with gain harvesting may come into play.  Check out our blog post on Do I need an investment manager? as well.
 

What happens to a double trigger RSU if you leave?

This will depend on the specific plan document for your company.  
 
Generally, most double trigger RSUs are like regular RSUs at termination:
 
  • If you have double trigger RSUs that are not time vested, those will expire immediately.
  • If you have double trigger RSUs that did meet the time vesting component, it may depend more on whether termination was ‘for Cause’.
  • In this case, ‘for Cause’ termination may result in complete termination.  ‘Not for Cause’ termination is gentler and usually allows you to be eligible for the time vested RSUs to vest at IPO or exit.
This can be a bit more complicated tax-wise as well if you leave the state you were working in as the RSUs ‘Service vested’ too.  
 
SeedSafe has worked with IPOing tech professionals since 2016 and we’ve gone through this many times.  You may only experience it once, but the outcomes can be life changing.  Our goal is to empower you with clarity and understanding of the process and outcomes.
 
We recommend all IPOing employees to bring on a financial advisor during the process to make sure nothing falls through the cracks.  If you are looking for a financial advisor and tax advisor to help you through the process, please reach out to us.
 
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The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.
 

What should I do if my startup announces a tender offer?

startup tender offer

What does it mean for my startup to have a tender offer?

A tender offer is a startup’s way of providing liquidity to employees and offering shares to others.  Often we see this start to happen as the company gets closer to IPO or decides to delay IPO.  In part, this helps employees see the value of their hard work and in part helps the company provide stock to potential investors.

Generally, we see startup tender offers limited to a maximum of $X or Y% per person.  The more common caps we’ve seen are up to $1 million in value or 50% of stock outstanding.  This is because tender offers are generally fueled by investor money or profits and so there is a total cap.  If the tender offer is ‘oversubscribed’, that means there is more demand for tendering shares for cash than can be fulfilled.  In this case, your total request of shares to be bought back may be further limited.

Review your personal financial situation to decide whether participating in the tender offer is right for you.  

  • Are you hoping to buy a new home?
  • Are you expanding your family and want to get a head start on college funding?
  • Will you be leaving the startup soon and need to plan for a potential clawback?
  • Do you want to exercise more stock options and are facing a cash crunch?
  • Do you want to diversify out of your startup stock a bit for future flexibility?

There are many opportunities in selling back some shares in a startup tender offer.  Other questions can be found in our tender offer basics post.

What should I consider during a tender offer?

  • Why is the company doing a tender offer?  Is this an opportunity for investors to get in when they believe the stock is undervalued?  Or is this to provide liquidity while waiting for IPO/M&A?
  • What is the valuation the shares are being offered at?  If the shares are ‘underwater’ i.e. under the exercise price for options or RSU vesting price, you may feel differently about tendering the options.  Generally, there is no reason to tender stock options under the exercise price.
  • How do I feel my company is doing?  Are you surprised at the valuation?  Do you see a long road ahead for the company?  Or do you feel the company is at a lower point now with the right metrics to get it to an even better Series XYZ in a year or two?  Although your assessment is biased, it is something to consider and weigh the risk / reward of keeping more shares.  I like to ask the question as: If you had the value of what you expect from the tender offer in cash, would you buy company stock with it?  
  • What are the tax implications?  Each type of stock option and currently held share may have different tax implications in a tender offer. 
  • Which experts are in my corner to make sure I am considering the implications?  Consult with your financial advisor or tax advisor to plan for the best outcome.  If you are looking for guidance, schedule some time with us to think through options HERE.

What are the tax implications in tendering my shares?

  • Unexercised stock options:  the difference between the sales price and exercise price will be treated as ordinary income (compensation)
  • Exercised ISOs:
    • If held short term or less than 2 years from grant date, this would disqualify the special tax treatment and turn it into an NQSO sale.  We rarely recommend doing this since you may have already paid AMT taxes at exercise and will not be able to get a credit back.  This will be treated as ordinary income (compensation)
    • If held long term, this will result in long term capital gains/losses
  • Exercised NQSOs:  short term or long term capital gains/losses
  • Vested RSUs:  short term or long term capital gains/losses
  • Unvested RSUs:  these are generally ineligible for tendering

Beyond what type of income or gains/losses each type of stock will be, there is also the question of who is paying any taxes due to the IRS and state tax department.  We suggest reviewing your paystub post-tender offer to see what came through the paystub vs. what did not.  You will be liable for the taxes in the end, so it is better to know now than when you file your tax return.

Is a tender offer better than an IPO?

Startup tender offers can be rewarding and less stressful.  Instead of watching the market daily while you wait out your lock up period, a tender offer allows you to review your finances with a known price.  It is a great way to financially profit while waiting for an IPO or Merger to happen “one day”.

I love it when a long-time startup employee comes to us with RSUs and ISOs in a tender offer.  Then, we work together to find the best strategy based on their situation.  Our goal is to understand where you want to be financially and keep it front in center.  Then, we balance tax implications, risk exposure, and long term growth at a level you are comfortable with.

For many of our clients going through tender offers with RSUs and ISOs we are able to purchase ISOs, minimize AMT taxes and diversifying out a large portion of cash from the event.  This makes my heart sing for my clients!

Can a startup force a repurchase of shares?

This is often called a ‘Clawback provision’.  If a startup includes a clawback in the plan documents, the company may be able to repurchase shares at termination or in the case of an exit.    Typically, the buy back will be at the fair market value of the shares at that time and can prevent you from realizing the full value of owning the shares.  

An example of the downside of clawbacks can be seen in the Skype acquisition by Microsoft.  Read more about it HERE and see some in depth examples HERE.

Another example of a clawback in action is if you make an 83(b) election and leave before your shares fully vest time-wise.  The company typically has 90 days to repurchase any of your unvested shares at the same price you paid. 

Those are the most common examples of a forced buy back, but not something we commonly see occur as part of a tender offer.

In the end, the best plan for a startup tender offer is the one where you decide how this event can get you closer to your financial goals.

If you are looking for a thinking partner in how to optimize and streamline your finances, schedule some time to chat with us.

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The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.

 

Cash Reserves and Tax Reserves for Google RSUs (‘GSUs’)

GSUs and savings

Below is an excerpt from our ebook on How to Build Wealth at Google.  To view the entire ebook, sign up HERE.

Cash reserve and Tax reserve for GSUs

Speaking of savings goals!  While investing is best for growing your wealth over the long term, the short term still matters.  Holding a cash reserve can give you a cushion to fund short term goals & an emergency fund.   This is especially important if you are living off of some GSUs.  The last place you want to be is waiting on that good old GSU vest and trading window to happen because the kids’ annual tuition is due.

Having a safety net set aside for a rainy day can help you feel more secure and less worried. We recommend you hold at least 3 months of living expenses. If you want to feel more secure or are the sole earner, consider saving up to 6 months.

Consider other savings buckets for: kids’ education, home remodels coming up, saving for a home purchase, a tax reserve for what you might owe, etc.

The goal of these reserves is to create a stable home for expenses coming up in the next year (to a few) instead of being at the mercy of the stock market.

High-interest savings accounts may offer better returns on cash during a volatile time in the stock market.

How are GSUs treated for tax purposes and why do I need a tax reserve?

At Vesting

GSUs are generally taxable as ordinary income (like your salary) when vested.  This income, and any tax withheld (federal and state) at vest, are reported on your IRS Form W-2 in the year the units vest to you.

Example: If your salary is $150,000 and you had GSUs vest at a value of $100,000 for the year, you received $250,000 of total compensation.  So you would see the total on your W-2 Box 1 as $250,000.

There is an information section of the W-2 that will show the RSUs amount further broken out.

This is why maintaining your trade confirmation or statement from the custodian (i.e. Morgan Stanley) is important.  You will need to know your adjusted basis in the shares held after vesting.

If you miss those details on the supplemental detail to the IRS Form 1099-B for your stock account, then you could be paying doubled up taxes.

Some employees are surprised when 40% of their vested shares are sold for tax withholding purposes.  Others end up with a surprise when they owe the IRS money on their tax return!  

This happens because tax withholding ≠ tax due.  Stock compensation is withheld at only 22% federally on the first $1M in stock/bonuses, which may differ from your actual effective tax rate in the end.  If your effective tax rate is higher than 22%, be sure to set aside a higher percentage to help fund the tax bill.  

At a state level, this can vary.  Some states have a flat income tax, while other states (like California) have a slightly different  withholding rate from tax rate. This means you may owe some taxes at year end.

At Sale

If you select for your shares to sell at vesting, then things are a little easier for keeping up with the adjusted basis.

If you decide to hold onto your shares after vesting, your stock will be treated like other investments.   After vest, the swings in the stock price will count towards capital gains /losses on your tax return.  This means you may owe more taxes on sale (if the stock appreciates beyond the vest value).

Since you already paid ordinary income taxes on the value at vesting, your basis will be the fair market value from your vest date.  The type of capital gains tax will be determined based on the length of time you hold the shares from the vesting date as well.  Long term capital gains rates apply when you hold the stock more than one year from the vesting date.

Example:  Using the above example, your basis in the shares would be $100,000.  If you sold the shares for $200,000 at a later date, you would be subject to capital gains tax on $100,000.   Depending on the time held, you would pay short term or long term capital gains tax (and potentially the net investment income tax).

However, if you hold the stock and the price drops below the value at vesting, you may recognize a loss.  You may be able to use those losses to offset capital gains from your company stock.  Losses greater than current capital gains offset income up to $3,000 a year.  Any unused losses carry forward to future years.  Unfortunately, you can not claim the taxes paid at vesting back.  This is one risk of many encountered in holding your company stock long term.

Example:  Following with the above example, if your basis in the shares is $100,000 and you sold the shares for $75,000 at a later date, you would have a loss of $25,000.  Depending on other investment sales, you may be able to offset this against other investment gains or not.  If you do not have any other investment sales during that tax year, you would only be able to claim $3,000 of capital gains loss on your tax return.  The remaining $22,000 loss would carry forward to future tax return.

For Googlers, this wouldn’t happen unless you sold all stock and were no longer receiving GSUs monthly.  For most Googlers, any loss on your stock sale would be considered a wash sale.

What is a wash sale?

A wash sale is an IRS rule that prevents a loss being taken on the sale of a stock if you repurchase that stock within the same 30 day time period.

This is where monthly vesting can hurt.  Because the majority of your vests will be within a 30 day time period, your sales are more likely to be subject to this rule.  So please do not consider losses on your stock useable against your gains until you look at the Form 1099-B after year end.  This form should show how many of those losses were considered ‘wash sales’ and disallowed for use on your tax return.

The good news is that you will get to use it eventually.  For now, it is built into the basis of your current Google shares until shares are sold and no more vest within a 30 day period.

It’s complicated.

Interested in learning more about our thoughts on Google for employees?  Check out our page here.

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The above discussion is for informational purposes only.  Recommendations are of a general nature, not based on knowledge of any individual’s specific needs or circumstances, and there is no intent to provide individual investment advisory, supervisory or management services.