Guest Post by Jordan Taylor, CPA/PFP – Co-Founder of VestBoard
As the overall economy has continued to build positive momentum over the last few years, the IPO market has exploded, culminating in over $85 billion raised in 2014. With the recent surge, employees of these growing companies stand to capture the upside. The many varieties of equity compensation structures available to both C-level executives and key employees offer immense opportunities for planning and strategy around minimizing tax liabilities on an annual basis.
One common form of equity compensation is Restricted Stock Units (RSU’s), which are typically subject to a vesting schedule. A key component is the fact that they become compensation to the holder at the full market value (FMV) of the units that vested on that date. The employer will also sell certain shares to make withholding tax payments on behalf of the employee, which is reported on the W-2.
As mentioned above, employees of companies who have recently gone public–or are close to an IPO–stand to have significant wealth added to their bottom line. However, when tied to a wildly fluctuating stock price, it can be a bit unnerving.
Twitter is a good example. The company debuted on the New York Stock Exchange on November 7th, 2013 at $26 per share. After a monumental first trading day, it closed at $44.90. Fast-forward to 2014 and in less than seven months, the stock price went from a high of $74 to trading as low as $29 a share.
Imagine you worked for Twitter and had 100,000 shares as part of their compensation. Now picture the value of your portfolio falling from $7.4 million to $2.9 million in less than 7 months. If faced with a similar scenario it would certainly have me thinking about running for the exits (selling off all my shares). But before you consider doing that, keep in mind that it is also important to understand that blackout periods are common among companies. Blackout periods force employees to only have access to sell shares at various time periods (typically quarterly). Picture this: You may find yourself watching the stock price plunge to historic lows and not be able to do anything about it.
After reading the scenario above, it’s important to consider a few things related to RSUs:
- What is my cash situation? – Depending on where your income has been historically and how much you are receiving in stock you would find yourself pay taxes at the top rates (39.6% Federal and 0-13% in your state). It is important to understand where your projected tax will fall so you can consider it for planning purposes.
- Do I hold for future long-term capital gains (LTCG)? – Your holding period starts when the stock vests, which means you would need to hold the stock for one-year to achieve LTCG treatment on any additional appreciation and if you have a crystal ball on where the stock will be in twelve months (or you have unbridled devotion to your employer) you may want to hold everything. If you received Apple stock or Amazon stock when they went to IPO years ago and never touched or sold everything, you would be doing just fine.
- Do I sell? – The benefit to selling immediately at vest is that you avoid any capital gains or losses, as your basis is the FMV on vest date and in most cases, the stock price hasn’t fluctuated significantly. You then have the cash available to either diversify or spend all of the money on toys, cars and fine art. All joking aside, it gives you flexibility and to leverage against having all of your eggs in one basket and to begin planning around a long-term strategy.
When faced with decisions regarding your equity compensation, make sure you consider the tax implications of holding/selling shares. It may be a one-time opportunity that you have to create lasting wealth for your retirement. Choose wisely!