Category: Investing & Tax Planning

SeedSafe Financial is an expert in stock compensation and tax planning. These articles dive into the nuances of stock types and ways to plan for higher income years.

Exercising Stock Options Pre-IPO

Exercising stock options pre-IPO means evaluating risks and rewards.

What will happen to the stock over time?
Will the Company continue to do well?
When could an IPO happen?
How long might the stock remain illiquid/unable to be sold?

Once you evaluate your risk, then it’s about understanding the ramifications of exercising the stock options.

What are stock options?

There are two types of stock options: Incentive Stock Options (“ISOs”) and Non-Qualified stock Options (“NQSOs”). Each is considered valuable as the company continues to grow. If the Company does well, the value of your options will increase and (hopefully) so will your personal net worth. However, it is important to consider the tax ramifications.

Incentive stock options (“ISOs”) are stock options available under a company stock plan. Qualified ISOs receive favorable long-term capital gain tax rates upon sale instead of ordinary income rates. In order to qualify, they must be held one year from the date of exercise and two years from the date of grant. Otherwise, they are considered non-qualified stock options (“NQSOs”).

In the year you exercise ISOs, you may be subject to the alternative minimum tax (“AMT”).

If you have NQSOs, exercising shares may trigger regular income tax. The difference between the ‘market value’ and exercise price is compensation and generally shows up on your W-2 in the year exercised.

What happens when you exercise pre-IPO options?

When you exercise pre-IPO options, you are purchasing the shares at the exercise price in order to own the shares outright.

The year you exercise pre-IPO options, you will pay the exercise price and pay any taxes due from the exercise. Depending on the price, you are potentially paying taxes now to avoid more taxes in the future.

This generally works if the company continues to grow well and the shares increase in value. The downside is that not all companies continue to do well and sometimes it can take years before you can sell them.

What is the best time to exercise stock options?

It is important to decide how much cash out of pocket you are willing to put towards purchasing shares and paying the taxes. You have no idea when you will be able to sell – so ‘betting’ on your ability to pay is a no-go.

It is also a good idea to consider the risk of the company. Are they at Series B and struggling to meet growth expectations? Or are they at Series F with institutional investors and continuing to scale well/be profitable?

In other words, how much cash out of pocket are you willing to lose?

Once you are comfortable with the potential loss, you can determine other types of timing.

When you join: If you join a very early stage company, there may be a chance to file an 83(b) election with little cash out of pocket. This may help to start your time period for claiming capital gains treatment or the qualified small business stock exclusion (‘QSBS’). Read more about the qualified small business stock exclusion here. The downside is, you know very little about the company at this point. If you decide to terminate before your vesting period is done, you may lose out on some shares you already paid for. An 83(b) election should be used with care.

Down-turn in the market: If the downturn in the stock market lasts a while, tech startup valuations come due. The new 409A valuation may end up lower based on expectations in the market. If it looks like they will weather the storm and do well, this could be an opportunity to purchase the shares at a lower tax due.

Before the next fundraise: If a fundraise is expected, you may wish to purchase some shares before it closes in order to minimize taxes. Generally, upon a closing of a funding round, the share price must be reset based on the value the new investors assigned to the company.

Note: Beware the cap table lock period. This is the time when fundraising commitments are being incorporated into the cap table to know where everyone stands. If you wait too far into the fundraise, you may not be able to exercise shares during this time.

At S-1 filing: When the company has committed to the process of IPO, this may seem the least risky time to exercise shares. The risk is in what price/value it will be on the stock market and taxes, but it is at least becoming more liquid.

Again, beware the taxes!

For example, let’s say you were granted 100 ISOs on May 1st, 2021 and then you exercised them May 1st, 2022. You ended up paying AMT on those 100 ISOs in 2022 because the stock price went up significantly over that time.

Then, the company IPOs at year end, and you are able to sell some in January 2023. The ISOs sold will be considered NQSOs because they were not held 1 year from purchase date / 2 years from grant date.

So in 2023, you will pay taxes on them as W-2 income, but there will be no way to get back the AMT you paid on your 2022 tax return. This is when you hear about people who ended up paying 70%+ in taxes on their shares. Please involve a tax advisor!

This is why it is important to hold the ISOs for the required time period. If you sell them before the 2 year grant/1 year purchase date, you could end up paying AMT in one year and regular taxes the following year. Ouch.

A basic discussion of AMT and exercising stock options is HERE.

At Termination: Your ISO shares generally expire within 60 to 90 days following termination (check your plan document). If you do not exercise them, they may turn into NQSOs eligible for a future exercise, or completely expire. For our thoughts at termination, check out our post on What to do with stock options at termination.

At SeedSafe, we tend to look at ISOs over each year to understand what is best to do in the current environment.

When should I exercise ISOs this year?

As you save more money and are able to take a little bit of risk, then we recommend looking at exercising ISOs during each year. Think of it as dollar-cost averaging into your stock.

Spring: Consider an initial round of ISO exercises at a conservative level. The goal here is to maximize the AMT exemption based on $X to be used towards stock and income expected for the year. Once maximized, then you can consider the trade off in exercising more (depending on stock price & other factors).

The hard part for tech professionals is that your stock compensation doesn’t stay static during the year. What may look like $200,000 in stock compensation for the year could drop to $50,000 or go up to $400,000 and completely change the math on what an ISO exercise will do to your tax bill. This is why it is important to look at the risks and run a few scenarios to decide what risk you want to take.

Winter: This is a great time to do a wrap-up on how the year went financially and to decide if it makes sense to exercise some more shares. This is the time when calculating the tax bill will be easiest. More knowns means fewer surprises For other year end tax tips on stock, check out our article on Year End Tax Planning for Stock.

If you’d like a thinking partner in considering the risks and rewards of stock options, please schedule some time with us. We love helping tech professionals think through what the stock can do for them and what their trade-offs are in exercising or not.

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. You should consult a legal or tax professional regarding your individual situation.

Do I need an investment manager? or can I VTSAX and chill?

New families reaching out to us tend to have the best questions. How do you think about tax planning? What should I do for college for my kids? Do I really need an investment manager or can I do it on my own? You know, VTSAX and chill?

I love the marketing of VTSAX and chill, but not quite the implementation. So what do we think?

My hope below is to share a recap of how SeedSafe Financial considers our role as investment manager, and about investing as part of the financial work we do together.

Back to Basics

At the start of the year, I get to revisit how the previous year went and what we can look forward to in the current year. This week, I reviewed many market review reports to reflect on our strategy. Each year, we go through many ‘what ifs’ on changes in strategy to see where we might want to change it…but we always come back to the fact that the basics work.

When I think about 2022 from an investment perspective, and what that means for 2023, I really can’t put it better than JP Morgan.

“Lower valuations and higher yields mean that asset markets today offer the best long-term returns in more than a decade. It took a painful slump in stock and bond markets to get here, and the worst may not yet be over.

But after a year of turmoil, the core principles of investing still hold firm.”

The core principles of investing. Back to basics. No matter where we are in a market cycle, our number one goal is to keep the basics in mind.

What are the basics of investing?

You buy an investment, like a stock or bond, with the hope that its value will increase over time. We take the risk of investing with the hope for greater returns in the long term.

First, look at the risk level of an investment and the potential reward to determine whether it has a place in our basket of investments.

Next, we review our basket of investments to determine our best guess at how to minimize risk overall and grow the basket of investments.

Then, it is about your philosophy of how to grow the basket best.

Our philosophy of investing

1. Your time in the market is what matters: focus on long term premiums instead of short term market cycles (timing the market doesn’t work)

2. Diversification: No asset class will outperform all others every year

3. Know what it is there for: What risk level is right for where you are now and how does that change as you reach different points along the way.

What if you want to buy rental property?
Why does it matter if you become an accredited investor?
How should your investments change over $2 million?
What if you want to take a meaningful sabbatical within the next few years?
How can you ‘retire’ (aka own your own time) by age 55?

The first two points we can guide you through. We can bring forward our research and understanding of long term markets.

Our work together as a team should be on #3 – what we can plan for and the risk level you want/can/need to take. It all comes back to your life, and how you want to live it. Investments are a tool to support your life.

So let’s talk about risk. If you live in California, which many of our clients do, you know there will be a huge earthquake at some point. You don’t know when it’s coming, but you know the risk is very real. So instead of living in fear, what do you do?

You decide what risks you are willing to take on and what isn’t worth the trade off to you. This may mean having your home reviewed for structural integrity and shore up any deficiencies. You may have a plan for ‘if the big one hits’ with family on how to communicate, meet up, etc. In the end, you will minimize the risks you can control. Or you may decide to move out of California and avoid the risk all together. And both of those options are okay, because you are the only one who can decide what risks you are comfortable with.

Side note, if you do decide to move out of California, I recommend looking at our blog post on Tax Implications of Moving out of California.

The nature of the stock market is similar.

Our work as ‘the investment manager’

We know at some point there will be a recession or large decline, but we don’t know when. So we start with diversification and ensuring we are adding many areas of the market (both US and international) and bonds to the basket.

Funnily enough, 2022 was a year when certain markets lost nothing (Portugal stayed flat) and some other markets were down by less than the US markets. It hasn’t happened in a while, but it’s a good reminder.

These ranges of outcomes are why being a well diversified investor into global markets can really make a difference over time. We never know what exactly will happen politically or economically, but by exposing ourselves to the entire market, we capture a better long term outlook.

Then, when an event, like our current sustained draw down happens, we review history to get an idea of what may be helpful as a small tweak. Past performance is never an indicator of future success, but there are key themes we can lean into.

We ‘shored up’ our portfolio to optimize for where we are in the market cycle with value leaning funds and bond updates. These changes also opened the door to tax loss harvesting for many. For more information on how to think about down markets, check out our blog post here.

There is no universal performance across all investors – we all contribute at different times during the year or have different investment allocations based on what risk we can take. So actual performance will vary. We still keep the long term perspective in mind.

Our work together

Our work together is to be an open dialogue where we can talk through where you are. I don’t want to know ‘your best self’, I want to know the whole you. Because then we can walk together and see where education or clarity might further empower you to make the best decisions for your future self.

We review cash savings, upcoming expenses, and further investments you plan to make. Many of our clients are invested in real estate, private funds or private companies (maybe even your own employer!). Our work together is to decide what risk level your remaining basket of investments should take on.

Then, we sit with it together in the good times and bad times. We discuss your questions and thoughts along the way. And we let time and diversification do the hard work. Is that something you are interested in? Then this might be the relationship for you.

Year End Tax Planning for Stock

This month, I was a panelist for a year-end tax planning webinar for financial advisors at myStockOptions.com. We discussed year-end tax planning strategies for tech professionals. Below are some of the points I shared that you may find useful. You can also read more about it on Forbes here.

What is year end tax planning?

Year-end tax planning is our time to review how the year went financially and to see what actions we can take to change our tax outcome for the year. These year end tax planning techniques should help us make the most of our tax situation.

For tech professionals, review stock compensation given this year and expected for the next few years. Then, you can determine which strategies you may utilize based on where the stock price is today.

What are the 3 basic tax planning strategies?

When we think about tax planning, we are looking at three components

How can we reduce income this year? Does it make sense to?
What tax deductions could we lean into? What are our charitable goals?
Where can we defer taxes for future years?

Ways to reduce income

When we look at reducing income from a tax perspective, we are making the decision to not receive cash to spend today for the benefit we expect.

You may maximize your 401(k), do a Dependent Care FSA if you have kids in child care, and max out your HSA contribution for the year.

For tech employees with stock options, you may review expected taxable income for the next few years and decide what exercises make sense.

If you have a lot of capital gains each year – either through capital gain distributions or sales, you may review tax loss harvesting strategies. Consult your tax advisor to ensure this meets the IRS guidelines.

Increasing tax deductions with charitable giving

Increasing tax deductions for tech professionals generally means leaning into charitable giving strategies.

Step one is to know what your charitable intent is. You certainly don’t want to let the tax tail wag the dog!

Step two is to consider how to get the biggest tax benefit. Identifying your lowest cost basis stock and donating them to a Donor Advised Fund when you are in a higher income tax year may be advantageous.

This allows you to recognize the market value of your stock for the charitable contribution. You also won’t be forced to sell the shares first and recognize the capital gains. So this may be better than giving cash. Consult your tax advisor for limits and best practices.

Deferring taxes for future years

What we can’t minimize tax wise, we can still consider for deferring into the future! Sometimes I feel like we focus too much on today and forget the bigger picture. Tax deferral can be just as important.

Do you have young kids? Set up a 529 plan and consider a large contribution. This may allow you to grow investments over 10+ years without recognizing capital gains when you sell them for school.

Planning on charitable giving long term but not sure who you want to give it to yet? Set up a Donor Advised Fund to begin contributions now and allow those funds to be invested for a longer-term goal.

Keeping your taxable investment portfolio in mutual funds? It may be beneficial to convert those to an ETF strategy since they do not have the same rule to distribute 90% of capital gains each year as income to you for now.

Sitting on Qualified Small Business Stock with a looming acquisition? There may be gifting strategies to consider.

How does that apply to my stock this year?

In a down market, your strategy might switch to increasing income. If you expect this to be a lower income year compared to future years (hopefully) then this may be your time to lean in. We wrote more about this in our post What should I do in a Down Market?

In a down market, the biggest things for year end tax planning on my mind are:

Review your family burn rate to know what you truly can lean into stock wise. All stock compensation is subject to restrictions. This may be due to trading windows each year or just illiquid pre-public company stock

Review your stock for positions that do not add to your current portfolio strategy and may provide tax-loss harvesting wins

Consider converting pre-tax IRA funds to Roth IRA funds if your total compensation is much lower than expected this year due to a lay-off or stock decline. The best opportunity is when you have cash on hand to pay the taxes for this conversion as well so the full amount may be included in the Roth IRA

If you are at a startup with incentive stock options, consider whether it makes sense to exercise ISOs

Also keep an eye on the 409A valuation expiration date since a down market may mean a lower 409A valuation or minimal increases

How should I think about this for early 2023 tax strategies?

Review your job expectations and career goals. If you plan on making a move in 2023, you may want to consider how that changes your income expectations and the impact of your stock compensation.

What do you expect to vest in stock compensation next year? This will help you understand how taxes may change and when you might want to change your strategy

Do you have any options expiring? What do you need to consider if the company cannot go public before 2024/2025 now?

There are many tax strategies to consider and the right ones for you may be different for another. It’s important to view these as part of the bigger picture of your finances and what will help you get closer to your most fulfilled life.

If you are looking for a financial partner to help you live your most fulfilled life, schedule some time with us to chat. 🙂

What Happens to my Stock in an Acquisition?

Tech professionals have such an interesting life from a stock perspective. You work hard to understand your offer letter, these weird stock things, and what that means from a tax perspective. The fun doesn’t end there – now an acquisition turns your beautiful plans into reality!

What happens to your stock in an acquisition depends on a few things.

The kind of acquisition it is
The structure of your company
What kinds of stock and/or options you have vested

Types of Acquisitions

Acquisition Type – LLC or Partnership

These can be quite a bit trickier. An LLC or partnership may be acquired for their stock or for the assets within the LLC/partnership.

If the LLC / Partnership is acquired by an ‘asset sale’, then your next K-1 will show the character of those gains. This may include: capital gains, ordinary income, interest income, debt cancellation, etc. It may be harder to estimate the impact of the sale. We recommend reaching out to your tax advisor for more information in this situation.

Acquisition Type – C Corps

Let’s say Company X is going to buy Company Y.

Company X will offer a ‘purchase price’ and this can be made up of a few components:

Cash,
Company X stock, and/or
Promissory notes

Depending upon the offer components, this will trickle down in what you personally receive for stock held.

Retention bonuses or retention stock grants will be made to individual star performers. The goal is to retain employees to ensure a smoother transition into owning Company Y.

Many executives find themselves terminated in the acquisition, so review your original contract for an acceleration clause. Does this sound new to you? If so, then we recommend negotiating this in your next compensation package. Find out more here.

What happens if I own stock in a company that gets bought out?

When you own stock in a company, stock certificates will be exchanged for either cash, cash and stock, or stock. It doesn’t matter if the stock is acquired through vesting RSUs or exercising stock options.

Most of the Big Tech companies tend to purchase startups for all cash. Smaller tech companies, who are acquiring another company for technology or market share, may not have the cash to put down. In those cases, a cash and stock purchase makes more sense.

Generally, the timeline goes like this:

Your company notifies you of the acquisition
You parse through legalese to understand if it is a cash purchase, stock and cash purchase, or other type of purchase
There will be an estimated closing date announced where the majority of the transfer will occur (generally within 6 months)
You will be subject to an ‘escrow’ where a certain % of your stock is held until all expenses are settled (within one to two years)

If you acquired the stock long ago, this is the time to review whether you meet the Qualified Small Business Stock exclusion. Read our blog post about it here.

If you exercised options in the last year, you will want to understand what that means for you tax-wise. One of the down sides of exercising ISOs is when you decide to take on a big AMT tax bill in hopes that the price will rise. Only, you find out your company will be acquired less than a year later. In that case, you have a big AMT credit and not a high chance of recouping it. Whomp whomp.

Any cash received will be considered a ‘sale of your shares’ and taxable at the time of the acquisition.

Stock and cash received for your company stock will be taxable to the extent cash was received.

A stock for stock transaction means your original basis and purchase date continues on. This will be portioned between the new amount of shares received by the acquiring company.

Clear as mud? Then it’s time to schedule an introductory meeting with us so we can chat through your particular situation.

What happens to my stock options in an acquisition?

Your stock options may go through a similar process, but on the original vesting timeline.

If you hold vested stock options, the company may pay out cash for these or provide you with a new grant in the acquiring company.

Once the acquisition is announced, you will no longer be allowed to exercise stock options. So if you see a lot of closed doors and people you don’t know coming into the office, that may be a sign to ask what’s up and consider your options 🙂

What happens to my future vesting schedule?

If you have unvested stock options or RSUs, these will move to either future cash payouts or new grants of the acquiring company stock.

You may also receive a retention bonus or retention stock grant as a way to motivate you to remain with the acquiring company for 2 additional years.

Should I sell my stock after acquisition?

If your company is acquired for stock, and it is priced very well, consider selling a large chunk. Many announced acquisitions bring the speculation of a beautiful future together and help buoy the stock price.

Most likely, if your company is being acquired, you had a lot of illiquid shares that were more ‘paper money’ than real money. Now is the time to make the most of the opportunity. Prepare for your future by investing in the stock market and considering your options for furthering your community.

Depending on the type of sale, you may have a great opportunity to do some gifting and charitable contributions with stock to minimize taxes.

Congratulations on your acquisition! If you need any help, please schedule some time to chat with us. 🙂

Carta is a tool, but not law

As a financial planner, I love Carta. It is a great tool – no more paper share certificates or poorly scanned copies of stock agreements. Everything is in one place and Carta has a great estimator for ISO exercises. So cool, but it is not law. It still requires the correct inputs from your tech company and you.

This year, we had some new clients come to us who use Carta for their stock options and had some issues. The frustration and anger I feel on behalf of my clients is requiring a bit of a rant below. Here are our best tips for successfully navigating Carta.

What does Carta do?

Carta allows your tech company to easily maintain their cap table, stock plan documents, and equity grants. Carta also allows you, the tech professional, to see all your lovely grants in one place. It even allows you to connect your advisor. That way, you can create a strategy together (instructions HERE if you are interested in connecting your advisor).

Logging into Carta

When you log into Carta, you will see a ‘portfolio overview’ of your current (and past) employers where you have stock or stock options available. You can view any tax forms under the ‘documents’ section and view ‘Account’ to see your exercise history and personal settings.

If you dive deeper on a specific company, you will see your holdings, your option grants, and what is available for exercise. There is also a lovely option to view the exercise simulator in Carta.

Looking Deeper into the Carta Exercise Simulator

I have a love/hate relationship with the exercise simulator. So when I get frustrated, I take a deep breath and remind myself that it is a tool, but not the law.

The exercise simulator is a very rough estimate. It requires two major things to even be a rough estimate:

1. Your company must have updated Carta with the correct FMV of the stock.

This is huge. HUGE. We’ve had clients find out that they exercised ISOs on Carta when it said $X FMV per share when in reality it was $Y FMV per share. Before you go through any exercise on Carta, please check within your company for the correct FMV per share.

This could be as simple as sending the CFO or Comp Manager a quick email: “Hey _____, I want to double check that Carta is correct before I request an exercise of my options. Is the listed FMV of $X still accurate?” This may save you $30,000 in AMT or even $200,000 in AMT. I’ve seen it happen. Want to learn more about alternative minimum taxes “AMT”? Check out our post HERE.

Please don’t let this be a surprise to you when you receive the IRS Form 3921, Report of your exercise of incentive stock options, after year end. It is entirely possible this form will show a different FMV per share than Carta did when you ran the exercise through their system. If your tech employer is a startup, the person in charge of updating Carta may be overworked and understaffed, so an update to Carta could be a low priority until it’s too late.

2. You must accurately estimate your taxable income.

To get a rough estimate in Carta, it is also dependent on you adding in a small little request of ‘what is your taxable income?’. If you forget about a large stock grant for the year, a bonus, a spouse’s income, or some capital gains you plan to realize, then the estimate will mean nothing.

If you do estimate your taxable income well, the estimate may still be far off if you are able to sell previously exercised ISOs in the same year. ISOs go into the alternative minimum tax equation at exercise and at sale. This is a time to go run an estimate with your tax advisor.

Keep your Address Up-to-date

Prior to exercising shares or selling shares, we recommend making sure your address is accurate within Carta. Some states/local jurisdictions may view ISO exercises as taxable and a mandatory tax withholding may pop up. It is best to know this surprise won’t happen and the income won’t be coded to a city/state you do not live in on your W-2.

Selling Shares through Carta

If your tech company offers a tender offer through the system, we recommend downloading every confirmation of sale. Carta does not have an easy place to find a ‘tax basis’ report within the tool. This could leave you in a tax cash crunch if you cannot prepare.

This will be on you and your advisor to construct and maintain a cost basis report so you know what your taxes look like as you are exercising and selling stock options.

Please don’t end up like the pig above. Please use the exercise simulator with care. Carta is a beautiful tool, but it is not law.

#endrant

What should I do in a down market?

This summer was the first time in a few years ravaged by COVID that we could finally go out and play as a family again. It also was a time for a down market to hit. Higher gas prices and inflation nipping at our heels wasn’t fun to witness while traveling.

A down market feels risky and unknown. Leading to further questions about: How can I prepare during this time? Where should I be putting my money? Should I be selling my vested company stock / RSUs?

How can I prepare during the down market?

Now is the time to reassess your family burn rate. Those tried and true words of ‘always have an emergency fund’ rear their head again! Are you living within your salaries? Do you require additional funding from your RSUs or stock options? How can you give yourself the most leverage to ‘wait out’ this season of a down market.

Consider tracking your expenses through a budgeting tool like YNAB or mint.com. Even if you don’t follow a budget to the law, this will let you see a good trend line. If you’d like something more manual, you can use this handy spreadsheet to catch some of those non-monthly items that stack up.

Knowing your burn rate gives you the freedom to realize other opportunities.

If your burn shows you have a risk in not having enough cash, this also gives you time to build up your cash reserves. The rule of thumb is if you are a single breadwinner, 6 months of reserves is best. If you are a dual income family, then 3 months may be adequate.

Tax-loss harvesting. The ability to take advantage of tax losses on your tax return is a pretty significant opportunity, especially for folks with large portfolios or equity comp. Tax loss harvesting works by selling assets at a capital loss and using that loss to offset other capital gains. This type of strategy can only be employed during down markets or high volatility in an asset class. During years such as 2022, you may be able to harvest a good amount of losses to help smooth and optimize your tax bill.

This gets into a very technical zone to do yourself. The loss must have substance to be utilized. I love this super nerdy and well outlined discussion from Kitces on who benefits best in this situation (with visuals) and the pitfalls if you are attempting this yourself.

Converting IRA funds to Roth IRA accounts. Depending on your taxable income for the year, there may be an opportunity here. The primary advantage of Roth assets is their current tax-free nature in growth and qualified distributions. This conversion will generate taxable income now, on hopefully ‘lower priced’ assets than if you did the conversion in the future. In essence, you choose to pay a tax bill now rather than in the future. One of the variables you should be mindful of is the Federal & State marginal tax bracket and your effective tax rates. Please consult with your tax advisor before engaging in this strategy.

Where should I put my money in a down market?

Once you know your burn rate and cash on hand, any remaining cash can go towards future growth.

If you have a big purchase to make in a few years, you may wish to take less risk in your investments and go for a well diversified stocks and bonds portfolio.

If you have cash on hand that you believe you won’t need for many years, this may be a time to look at exercising lower valued stock options.

Exercising incentive stock options (ISOs) in a down market

One of our favorite opportunities to explore during down markets is the exercise of Incentive stock options (ISOs). This strategy is a concentrated risk that requires a strong understanding of how much cash you are willing to lose. Once you know how much cash you are willing to ‘lose’ towards such a risk, you can consider the options below.

Private companies: If your company is private and they take a “down round”, employees with Incentive stock options (ISOs) may have an opportunity to get a bigger bang for their buck. ISOs may be subject to AMT tax at exercise on the value between the share value price and the exercise price. During a down round, the employee may be able to exercise more options before hitting the AMT tax threshold. Please be mindful that sometimes there are exercise lock out periods and other restrictions.
Public Companies: Very similar to private companies; however, their valuation fluctuates minute by minute on the public exchanges. During these decreases in stock price, stock option holders may want to exercise shares when they feel the price will be “low & optimal”. Again, this is always a risk since you are going off of a feeling in one particular stock. If you are sure you can take the risk, this may be an opportunity for you. Generally, public company tech employees can exercise their options outside of a trade window. If you see your stock price is falling a decent amount, you may want to consider exercising options.

What if you already exercised early this year? Keep in mind that the AMT is an annual aggregate calculation. All ISO exercise value goes into the AMT calculation. One strategy is to sell previously exercised shares from the current year (which makes this a disqualified disposition treated as ordinary income and remove them from the AMT calculation). This may allow you to exercise a greater amount of ISOs at the same level of cash outlay if you are above the AMT tax thresholds. We recommend working with your tax advisor to complete this strategy.

Should I exercise non-qualified stock options (NQSOs) in a down market?

The philosophy behind this exercise is similar to the ISOs, but with the added complexity of taxes due at exercise. Remember, NQSOs will generate income once they are exercised and will be subject to required withholding taxes. Then, at your tax return time, you may owe additional taxes if your effective tax rate is higher than the taxes withheld at exercise.

It may make sense to exercise a small amount of NQSOs if you do not have ISOs, but be ready for the taxes due at exercise. If you have ISOs, you may be able to achieve more shares held through focusing on exercising ISOs instead.

Should I be selling my vested company stock / RSUs?

If the vest just happened, then yes, you should deeply consider it. This should be part of your strategy to diversify out of your company shares and into a well maintained portfolio that can do more work for you longer term.

For older shares, I would ask you at what price you are willing to part with it? If the stock was that price after vest, then why didn’t you sell it then? We often feel we know our company much better as an ‘insider’ and that the stock price will definitely reach $X or in three years will get to $Y. The number of times I’ve heard this, and it never got to that point, is very high. We don’t always know what the stock market will do in a shorter term because large players are pricing in their expectations as well. Leading to short term noise and erratic behavior. This down market has certainly shown that volatility time and time again 🙂

We believe in dollar cost-averaging out of company stock over time by selling RSUs at vesting. So at the least, consider selling pieces over time so you are not left wishing you had taken some off the table and less risk with your nest egg.

Tender Offer Basics

During a ‘down time’ in the economy, many companies may turn to tender offers to satisfy grumbling employees who expected an IPO. Other private companies may provide tender offers as the company becomes more mature and stable. This is generally in the later stage of the tech life cycle.

Tender Offers are a funny animal. Each company may do this a little differently. Generally, a funding round with an institutional investor will allow this. Then, it depends on the amount the investor will allow to go to a tender offer vs be invested in the business.

This creates a ‘cap’ of how much employees can sell in shares or options. Usually, we see this at around 20% of shares/options owned or $X (could range from $50,000 to $1M).

The majority of tender offers look at all share types equally. So if you own ISOs, NQSOs, or actual shares, you will be able to determine what mix of those will get you to the total 20% of shares available to tender.

How do you decide what to tender in an offer?

Each type of option (or actual stock owned) provides a different pro/con list of how to think about what to tender.

Things to consider:

For shares you own, are any on their way to being eligible for the QSBS exclusion?

Which options are above water (tender price > strike price)?

What liquidity do I need for the next few years? Do I have enough cash or investments I can pull from at this point?

What liquidity would I like to have for the next few years? Maybe you are working towards a new goal that could use a little extra funding

Do I plan on moving on soon to a new company? If so, then options will expire within 60 to 90 days of termination and will require a big cash outlay to exercise any (potentially)

For ISOs, if you exercise and sell immediately, they become compensation income and are treated like exercising NQSOs

Submitting your Tender Offer request

The company will need to confirm whether you can actually tender the full amount requested. There is always the possibility that a tender offer is ‘oversubscribed’ with more demand than expected. If this happens, the company will reduce the total amount of shares or options you can ultimately tender.

Once the tender offer is complete, review your next pay stub / the summary document you receive from the transaction.

Depending on the shares or options you tendered, the amount of tax withheld through the tender offer may not be enough to cover your total tax bill.

Please make sure you make an estimated tax payment on what you expect to owe in the future. It’s never fun to realize you are short on cash once the tax return is finally prepared.

Use the Tender Offer to Augment your Life

I hope you get to use a tender offer to lean into your values. There is nothing like putting a little more money away towards financial independence, buffering your cash cushion, or helping your community and family towards a better future.

Tax Implications of Moving out of California

COVID changed the way many tech employees work. The option for remote work changed the way many of you think about life and what you want out of life. Instead of waiting until financial independence, or worrying about job opportunities in the new location, you can move to the place you really want to be! For others, many tech firms are moving to second-tier less expensive tech hubs like Tesla moving to Texas.

That might be near family, towards a dream home, or maybe closer to nature and a community you value. What an absolute blessing!

You may take a 10% pay cut from your current employer, but what you get is worth far more than that. Now it comes down to the logistics.

Many of our clients moved in the last year to smaller tech hubs. This allows them freedom of time and money – to be close to family and friends, buy a place to call home, or to just explore a different environment. During this tax season, we found that a few clients are already receiving Requests for Information from the state they moved from. This can be a bit daunting, so we want to share best practices and things to be aware of.

What do the states ask for in a tax request for more information?

Each state can be a bit different in the request, but the goal is to understand whether you are truly a resident or nonresident for tax purposes. They may ask for:

– Official date you changed your status from resident to nonresident

– Documentation that supports this like

Rental agreement / home purchase documentation
Drivers license with date of issue
Voting registration
Updated insurance coverage and established health care in the current location
Offer letter displaying the new location and start date

– Whether you traveled to the state during the year and specific dates of travel

How many of those days were non-working days
How many of those days were working days
Whether you worked remote or in an office locally

The state’s intent is to ensure that income is appropriately allocated from your employment in the state. They are not trying to rob you of hard earned money, even though it can feel that way when you do not know the rules.

How can you prepare for your move to make this easier?

Alert your HR department for the exact date you plan to leave your state fully. Waiting a month or two to update this may mean more income allocated and additional stock compensation accrued to that state on your W-2.
Track your days/time spent visiting in your prior state once you move.
Make it 100% clear where you are. I know it’s a jumble to move across the country (I’ve done it a few times myself), but the longer you wait to establish your presence, the less of an audit trail you have supporting your new move.
Remember that your RSUs or stock options will still have a trail of income allocable to your prior state. Until the stock is recognized as compensation income, you technically earned a piece in your prior state. So even after you leave a state, there is a high likelihood that your next vesting or option purchase will show the allocation back to your prior home.

Moving between states is hard enough. Between packing, shipping, temporary housing, etc there are a million balls in the air. I hope the above information helps you prioritize which ball to catch a bit faster.

Selling your Startup? What the Best Investors Do

Did you know part of your startup sale can be excluded from federal taxes?

A provision in the tax code helps minimizes taxes for the wealthy investor and startup employee upon a stock sale. It’s called the Qualified Small Business Stock (“QSBS”) exemption. Most startup employees have no idea they can use this!

This allows a C Corp shareholder to exclude up to 100% of their gain from taxes, if they meet certain parameters.

To qualify for the QSBS exclusion, five criteria must be met (legal jargon to follow):

1. The stock must have been directly acquired via an original issuance from a U.S. C corporation (Sec. 1202(c)(1));
2. Both before and immediately after stock issuance, the C corporation’s tax basis in gross assets did not exceed $50 million (Sec. 1202(d)(1));
3. The C corporation and shareholders must consent to supply documentation regarding QSBS (Sec. 1202(d)(1)(C));
4. The C corporation conducts certain qualified active trades or businesses (Sec. 1202(e)); and
5. The stock must have been held for more than five years (Sec. 1202(b)(2)).

You can find a tax checklist for the requirements HERE .

Many early stage startups will meet these criteria. If you are FinTech, then you may need to do more analysis to see if you can be treated as QSBS. This goes for the other excluded industries as well.

Once you determine the startup is a QSBS, you can exclude part of the gain dependent upon when you bought the stock.

Federal Exclusion of QSBS Gain

Acquisition Period	Percent Exclusion (Regular Tax)	AMT Add-Back
Before Feb 18, 2009	50	7
Feb 18, 2009–Sept 27, 2010	75	7
Sept 28, 2010 and later	100	0

The remaining capital gain is taxed at a 28% capital gains rate instead of the 15%/20% long-term rate. This may sound like you are worse off, but the benefit comes in the amount of gain you can exclude from the taxable calculation.

Most sales for higher wage earners will trigger AMT. For AMT purposes, 7% of the excluded gain is added back to taxable income for the computation of stock sold before Sept 28, 2010.

You will also need to consider the Net Investment Income (“NII”) tax at 3.8%. This will be applicable under all scenarios when the taxable income threshold is met.

Let’s see how Qualified Small Business Stock works through an example.

Assume you sell your startup and meet the 5 criteria for considering this stock qualified small business stock.
Your regular ordinary income is about $500,000 with your spouse.
Your share of the business gain is $350,000.

Purchase Date: January 3, 2009

Your estimated tax would be calculated as:
$350,000 x 50% exclusion = $175,000 excluded gain
$350,000 – $175,000 = $175,000 taxable gain
$175,000 x 31.8% (28% capital gains rate + 3.8% NII tax) = $55,650 regular tax
$175,000 x 7% AMT add back x 28% capital gains tax = $3,430 additional minimum tax (AMT)

Estimated total tax due on business gain: $59,080
Estimated effective tax % of gain: 16.88%

Purchase Date: January 3, 2010

Your estimated tax would be calculated as:
$350,000 x 75% exclusion = $262,500 excluded gain
$350,000 – $262,500 = $87,500 taxable gain
$87,500 x 31.8% = $27,825 regular tax
$262,500 x 7% AMT add back x 28% = $5,145 additional minimum tax

Estimated total tax due on business gain: $32,970
Estimated effective tax % of gain: 9.42%

Purchase Date: January 3, 2011

Your estimated tax would be calculated as:
$350,000 x 100% exclusion = $350,000 excluded gain
$350,000 – $350,000 = $0 taxable gain
$0 x 31.8% = $0 regular tax
$0 x 7% AMT add back x 28% = $0 additional minimum tax

Estimated total tax due on business gain: $0
Estimated effective tax % of gain: N/A

What if you didn’t claim the Qualified Small Business Stock exclusion?

Your estimated tax would be calculated as:
$350,000 x 20% long-term capital gains rate x 3.8% NII tax = $83,300

Estimated total tax due on business gain: $83,300
Estimated effective tax % of gain: 23.8%

Now that you see the benefits, what do you need to do to claim the QSBS exclusion?

Make sure you have documentation to backup your belief you meet the 5 criteria.

This may include:

proof of initial capitalization at your purchase date (i.e. 3rd party valuation documentation – tying to your 83(b) election valuation)
proof of stock purchase date (stock certificates or copy of check) and
certification from the company that they are a U.S. C Corporation (i.e. IRS Form W-9)

Hire a tax preparer for the year in question. The simplified example above does not include a discussion of how each state may further tax your business gain. They will also make sure they have the documentation to support the QSBS exclusion on file in case of audit.

Where are you in your start-up adventure?

Making the jump from Corporate life to a Startup?
Did you just receive your stock option grant?
Are you thinking about purchasing your vested options?

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If you live in a state with it’s own form of state AMT, this further complicates the matter. AMT calculations can be difficult and you may need professional help, such as that of an accountant, tax attorney, or someone experienced in complex tax returns.

How to Change your Life with your Bonus

Surprise! You received a little extra cash for the year. What should you do with an unexpected or year-end bonus?

A bonus is an opportunity to start a habit that will change your life for the long-term. Many times, we end up spending bonuses on a present to ourselves for all our hard work. Instead, allocate it toward goals that will pay compounding presents to your future-self!

The top four ways to use your bonus for a present to your future-self are:

Pay down high-interest debt
Fund emergency savings
Fund retirement savings
Invest

Pay down high-interest debt

What defines ‘high-interest debt’? In my mind, this is debt that you don’t pay off on a monthly basis and has a higher interest rate than 8%.

List out your high-interest loans and credit cards, the balances outstanding, and what the interest rates are. Stack the debt by highest interest rate and start hacking away. Doesn’t that feel good?

But here is where the habit part starts. Paying off your debt and keeping it paid off are two different things. If you make the decision to pay off your debt, you should also make the choice to keep it paid off. Take another look at your spending habits and put together a budget to make this good feeling last.

Fund emergency savings

Do you have 3 to 6 months of savings on hand for emergencies only? If you think your credit card limit counts, guess again. Having three to six months worth of savings is vital in today’s economy. You may bounce around from job to job more often or decide you need a sabbatical to check back in with yourself. Not having this money available for breathing space wreaks havoc on your emotional well-being.

Fund retirement savings

Do you have a 401(k)? Are you making the maximum contribution? If not, this is a chance to save for your future self and reduce your taxable income. Cha-ching!

Invest

A lot of articles I read are focused on setting the right tone with budgets and savings. What do you do for your longer term savings goals? Maybe you want to take an international trip in 5 years, provide for your children’s college fund, or invest extra money so you have more options in the future.

Long-term success requires investments in yourself and in the financial markets.

Little tweaks now create huge differences later. The benefits of compounding interest and gains can change your life. Check out our philosophy on long term success HERE.

S chedule a free consultation to see how we can help.

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