Initial public offerings, or IPOs, have had a dramatic increase over the course of 2018. Tech employees can expect this trend to continue into 2019 and beyond, which is incredibly exciting! Current and former tech employees who hold stock options and shares often have questions about what to expect, or what actions they’ll need to take, during the year of their company’s IPO. Although the answer varies, there are typically two main focus-points that employees need to pay attention to:
Knowing when to exercise your stock options, and how to sell your options in the wake of an IPO, can make a huge impact on your finances from a tax standpoint. IPOs can create a kind of financial frenzy among tech employees. Creating a plan in advance of your company’s IPO helps you to develop a strategy with a level head, and can mitigate the risk of making emotional, less-than-stellar financial decisions.
3 Tax Things to Beware of After an IPO
Typically, employees need to pay attention to three specific ways that an IPO can impact their taxes:
1. Watch out for RSUs.
RSUs (or Restricted Stock Units) trigger ordinary income tax when they vest, and many RSUs have a vesting schedule that’s reliant on an IPO. This means that your RSUs will vest, or be considered income, after an IPO.
Because your RSUs are now considered income, they’re taxed like cash, and viewed the same way your salary or bonuses are viewed by the federal government. However, unlike a salary or bonus, your RSUs aren’t cash – they’re given to you in the form of shares. This puts you at a tax disadvantage, because you’re getting taxed on income that isn’t liquid or available for you to use immediately.
Let’s back up a second. Right now, you might be saying: My company just went through the IPO process, my RSUs have vested, but nothing’s happened with my income taxes.
This may be the case – for now.
Sometimes, your RSUs will have double-trigger vesting. This means that their vesting schedule is time-based, and they’re triggered by an event (like an IPO). So, over the course of the year of your IPO, all of the RSUs you’ve accumulated will vest. After that, they’re reported on your Form W2. When you file your taxes next year, you could receive a W2 with over $1 million of income! If your salary is typically half of that (or less!), this is a huge tax exposure.
Let’s back it up again. You may be thinking: Hold on a second – don’t they withhold taxes on my RSUs? I’m good then, right?
Although taxes are typically withheld on RSUs, your organization won’t withhold enough of them. You should always expect to owe taxes after your IPO. Prepare ahead of time to avoid a shocking and unpleasant bill during tax season next year.
2. Be aware of new tax forms.
Typically, employees are used to receiving a Form W2 when it comes to filing their taxes. It’s true that some of your RSU and other stock options will be reported on your Form W2. However, your IPO will probably result in some new tax forms you’re not familiar with – and nothing is worse than an unexpected curveball during tax season.
These forms might be:
- Statement of Taxable Income
- Form 3921
- Form 3922
- Form 1099-B
Let’s dive into what each of these forms entail, and why you should keep an eye out for them.
Statement of Taxable Income
This will be provided by your employer and give you a detailed overview of all your stock options. This should help you (and your accountant) navigate your taxes in the coming filing season.
This form is also provided by your employer. It’s directly connected to your Incentive Stock Options (ISOs). Your employer will fill this form out to note each transfer of stock to any person following that person’s exercise of their ISOs.
Again, this form is provided by your employer. It’s connected to your Employee Stock Purchase Plan (ESPP). You’ll need this information when you sell your stock, so make sure to keep it for your records.
This is provided by your brokerage or equity awards account. Form 1099-B details the cost basis reported to the IRS on the sell of your shares.
You’re going to need all of these forms to accurately prepare your taxes, even if they appear to be information-only. Having them ready when you go to file will speed up the process, and help to ensure that you don’t overpay on your taxes next filing season.
3. Look into new tax planning opportunities.
Companies often roll out new offerings to employees after an IPO. Two common employer offerings are:
A 10(b)5-1 helps you to set up a trading plan that doesn’t lock you into a set trading window. The plan allows you to trade a set number of company shares at a set price, as long as you agree to sell the shares at a predetermined time. This time is completely set by you, the employee. This can be a convenient tax planning tool that helps you to side step the frustrating trading schedule of other plans and stock options.
An ESPP is a stock trading plan for employees that allows them to purchase company shares at a discounted price. Employers usually allow you to set up share purchasing through payroll deductions.
What’s Your Strategy?
If you know an IPO is around the corner, it’s time to start planning ahead. Having a strategy in place that determines what you’re going to sell (and when) can help you to mitigate the immeasurable impact that taxes will have on your income after IPO.
Your first step should be to sell RSU and new ESPP shares ASAP. This helps you to free up the necessary cash that will help you to pay your taxes in the filing season after IPO. Selling your RSUs and new ESPP shares also helps you to diversify your investment portfolio. Even if your company is doing incredibly well, that doesn’t mean it’s going to be that way for forever. Having a diverse portfolio that doesn’t have too much stock in one company (even if that company is your company) is in your best interest. Don’t put all of your eggs in one basket, so to speak. Selling these shares also helps you to avoid adding to your already-concentrated stock position with your company, and helps you to avoid paying regular income tax on RSUs and being limited by capital losses on the shares. In short, selling RSUs and ESPP shares helps you to mitigate the impact of taxes and risk on your investment portfolio.
Get organized. Don’t wait till April to get organized for your April 15th tax deadline, start now. Waiting to get organized for tax season is never a good idea – but this is especially true after an IPO. You have too many pieces to your financial puzzle right now to procrastinate. The longer you wait, the more likely you are to feel rushed and potentially miss a key piece of information that could save you thousands on your taxes.
Plan around your trading windows. Trading windows are something new you have to deal with after an IPO, and it might feel stressful to suddenly have a new timeline to consider. However, as long as you’re staying tax aware when exercising and selling within your trading windows, you should be able to trade successfully in a way that mitigates the impact of taxes come filing season.
If you don’t have a plan in place around how you want to approach your various stock options in a given trading window, you risk missing opportunities to sell your shares in a way that reduces taxes owed. You also put yourself at risk of incurring some hefty costs if you miss your window – which is something nobody wants to deal with.
After an IPO, you need to be especially in tune with your financial life. If you bury your head in the sand and continue to treat things as “business as usual” it’s likely that you’ll end up paying more in taxes than you needed to due to missed opportunities. Working with an advisor can help keep you organized in the wake of an IPO, plan for the impact of taxes on your higher-than-average income after your stock options vest, and execute your strategy over the course of the coming year.