5 Steps to Solve Your IPO Tax Issues

by | Mar 20, 2019 | Financial Independence, IPO, Tax Planning

5 Steps to Solve Your IPO Tax Issues

by | Mar 20, 2019 | Financial Independence, IPO, Tax Planning

ipo and taxes

Every year, it’s the same deal:

You review your finances from the year before, and try to plan out your tax strategy so you don’t have to pay through the nose to the IRS. Usually, this means finding ways to keep yourself in a lower tax bracket.

(Because why wouldn’t you want to keep more of the money you worked hard for? ????????‍♂️)

I know I’m 100% in favor of you making smart financial moves to advance your financial situation and retirement plans.

Thing is though, in the United States, we’ve got a marginal tax rate on a progressive tax system, meaning you don’t pay the same tax rate on all your income.

The first ~$9,700 (taxable income, after all deductions) you make, for example, is taxed at 10%. Everyone pays 10% on this first ~$9,700, whether you earn it in a week or whether it takes you six months to earn that much.

But as you earn more income, the more you pay on the additional amounts you earn, up to paying 37% on ordinary income like salary and bonuses. For a single person in 2019, you start paying 37% tax after earning $510,301. That means, for every $1,000 you make beyond this benchmark, that’s an additional $370 in taxes. It can add up fast, especially when your company goes through an IPO and taxes on the money you make there come into play. 

 

IPO and Taxes Can Get…. Complicated. (& Stock Options Change Everything)

In a simple world, money in = income, and income = how you determine your tax rate.

So for example, if last year you earned $200,000 with a 15% bonus, you’ll pay taxes on $230,000.

And if this year you get a raise to $250,000 with a 20% bonus, you’ll pay taxes on $300,000.

But in the startup world, it’s usually not this simple… especially when stock options and IPOs come into play. And especially when you consider that the stock market changes daily.

And while most people realize their stock options and RSUs will be taxed differently, they’re not 100% sure how.

For example, the fact that stock prices change daily can have a huge impact on how much income you realize in a year. That amount then affects the tax bracket you have to pay into, and how much you end up owing on your overall tax bill.

 

For Example, the Twilio IPO and Taxes

In 2016, Twilio IPOed at $15 per share. And just for funsies, let’s say you were a Twilio employee at the time with a $180,000 RSU grant right around IPO, with total vesting over four years.

$180,000 / $15 = 12,000 shares. So that’s 3,000 shares per year, for four years.

(And to keep things simple, we’ll say your shares vest annually on the IPO anniversary.)

If the share price was fixed at the $15 it started at, that’d be $45,000 of additional income considered in your tax bill every single year.

But… that’s not what happened.

Instead, in 2017, the share price went up to $29.71, which means you got $89,130 in additional income that year, just by having those shares to your name. (And, yes, that’s an additional $89,130 you have to pay taxes on.)

In 2018, the share price went up to $55.25, 268% more than the value at grant, which comes to $165,750 in ADDITIONAL income.

You can see how if you weren’t planning properly, your tax bill would come along and totally knock you off your feet, can’t you?  

 

Now, of COURSE We Want Your Share Prices to Go Up

Because… when is more money in your pocket not a good thing? (Isn’t that one of the HUGE benefits of working in tech?!?)

So yes, of course we want your share prices to go up so your wealth can too.

But more than just that, we want you to be aware of what these rising stock prices will do to your tax bill. (That way, you can prepare accordingly & not be stuck with a huge bill you may or may not be able to pay.)

However, sometimes it CAN actually be best to sell your shares sooner to avoid a lower future share price. Taxes are just one part of the decision to sell.

It’s tricky, but let me explain…

 

IPO and Taxes: What it Does to Your Tax Bill

Before your company’s IPO happens, you’re usually paying your lowest tax rate. (Typically just your salary plus any bonuses you get.)

During an IPO, you’re at your highest tax rate.

You’re paying taxes on your salary and your bonuses, but you’ve also got to deal with YEARS worth of RSUs vesting all at the same time, which also counts as income in the eyes of the IRS.

Then, after an IPO, your tax rate is higher than before the IPO, but it’s usually not higher than that IPO year. You have your salary and your bonuses to pay taxes on just like before, but you’ve also still got some RSUs vesting, though they’re typically much fewer than the IPO year.

 

Plan Your Taxes BEFORE Your Company IPOs

You’re still with me… right?

(Just checking. ????)

Because now we’re going to get into a SUPER useful exercise that can help you decide what to do with your financial decisions before your company heads into an IPO.

Going through the next five steps will help you pay fewer taxes where possible, but still get as much money as possible added to your bank accounts to create more financial independence for yourself.

    Step 1: Estimate Your Taxable Income

Just a heads’ up, this may be a little tricky since the TCJA (Tax Cut and Jobs Act) was passed. We’ve yet to file tax returns under these new rules, but even with them in place, the best place to start is by looking at your 2017 tax return.

On that document, check out line 37 of Form 1040. This is your AGI (adjusted gross income).

With the new tax rules in place, subtract $12,000 if you’re a single taxpayer, or $24,000 if you’re a joint taxpayer. (This will be a great estimate of your 2018 taxable income before an IPO.)

If you’ve already filed your 2018 tax return, finding your taxable income will be easier. Just look at line 10 on page 2 of Form 1040. ????

 

    Step 2: Determine Your Marginal Tax Rate

Use the chart below to figure out where you fall in the federal tax rate chart.

Marginal Tax Rates

   

Taxable Income

Federal Tax Rate

Single

Joint

Up to $160,725

Up to $321,450

24%

Up to $204,100

Up to $408,200

32%

Up to $510,300

Up to $612,350

35%

More than $510,300

More than $612,350

37%

For example, if you’re single and your taxable income is $150,000, you are in the 24% bracket.

In this case, $1,000 worth of deductions would save you $240 in taxes. Or, a $1,000 more income will cost you $240 in taxes.

 

    Step 3: Figure Out Your Breathing Room Before the Next Tax Bracket

For example, if you’re a single taxpayer with $150,000 of taxable income from example above, you’ve got $10,725 to play with until you enter the 32% tax bracket.

It’s important to note though, that some tax brackets are very large & give you a lot of breathing room.

Moving from 32% to 35% for a single taxpayer, for example, gives you $306,200 worth of room to grow before you hit 37%.

 

    Step 4: Use Your Imagination & Predict Your Company’s IPO

More than likely, you’ll need to make some assumptions here, but just use your best guess.

(I know, I know. That’s not very accountant-like of me. ???? But if the IPO hasn’t happened yet, what can you do? ????????‍♂️)

Here’s what you need to write down on paper to start figuring out your financial plan of action:

  • When will the IPO happen?
  • What will the future share price be?
  • What’s the amount of income that will be added from RSU?
  • Will your tax bracket change from your RSUs? If so, to which bracket?

Also, take a closer look at your stock options and what you’re allowed to do with them. (Every company is different.)

Stock options are not as simple and straight-forward as RSUs: you get to choose when you exercise and when you sell.

This gives you MUCH more flexibility than with RSUs, where you basically have no choice in the matter after the IPO happens. The RSU will vest and be taxed, no matter what. But since stock options have so much flexibility built in, you can use them to add lots of value to your finances with smart, intelligent planning.

 

    Step 5: Plan Accordingly

Take some time to map out different IPO timings, and how that would affect your tax brackets.

It gets a little tricky here, because there are no cookie-cutter “you should always” plans when it comes to an IPO and taxes. Every single situation is so, so different. 

But just having it down on paper as something to look at and base your plans around can help you make some really intelligent financial decisions.

For example, I recently had a client who, with her typical salary & bonus amount was in the 24% tax bracket.

However, when her company’s IPO happened, the double-trigger RSUs she had skyrocketed her into the 37% tax bracket. (As in, she got A LOT wealthier.)

Because we had all this down on paper, we were able to make the decision to switch her retirement investments that year from a Roth 401(k) to a pre-tax 401(k), and we saved her $7,030 in taxes. (The $19,000 max contribution x 37% = $7,030 saved.)

We also knew that all the additional RSU income now made her incentive stock options less expensive to exercise, so we made sure to do some of that too. (AND we figured out ways for her to owe less in Alternative Minimum Tax than she would have the year before!)

Get Some Professional Eyes on Your Plan for an IPO and Taxes

No one IPO is the same, and even people within the same company can have very different financial outcomes as a result of the exact same IPO.

If you’re fairly certain your company’s IPO is going to happen soon and want to make sure you’re in a good position to handle it… both for your tax bill and for your future financial planning, set up a call with me or Jackie.

We’ve got years of experience serving tech employees, focusing on the San Francisco scene, but helping clients all over the country.

Plus, we’re one of the few firms that actually take the time to understand each individual IPO situation and how it reflects the individual… instead of just selling you a cookie-cutter IPO plan.

Plus, we’ll take your bigger financial picture into consideration, helping this one event do up to 10 years’ worth of work towards your financial goals… instead of just having it cost you a fortune in taxes.

READ MORE ON THIS TOPIC