The number of tech IPOs surged in 2018, and the momentum is expected to continue well beyond 2019. If you’re a current or former tech employee holding stock options or RSUs, you might be wondering what steps to take once your company goes public. Although the answer varies, there are typically two main focus points that employees need to pay attention to:
- Exercising
- Selling
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. In other words, your RSUs will vest, or be considered income, after an IPO.
What does this mean for you? You’re taxed on income you can’t immediately spend. And that can cause serious cash flow issues if you’re not prepared.
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?
Nope!
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.
Many employees are used to just receiving a W-2, but after an IPO, you’ll likely encounter several unfamiliar tax documents… and nothing is worse than an unexpected curveball during tax season. Understanding these forms is essential for accurate IPO tax filing:
- 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 will 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.
Each form plays a role in determining your capital gains and taxable income. Missing one could lead to overpaying (or underreporting), which both have financial consequences. Gather everything early to avoid last-minute stress during tax season.
3. Look into new tax planning opportunities.
After your company goes public, it might introduce new stock programs that affect your tax strategy. Two common offerings are:
- 10(b)5-1
- ESPP
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 sidestep 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.
These tools can help you manage your taxable income, avoid concentrated stock positions, and build a more diversified portfolio.
What’s Your Strategy?
If your company is heading toward an IPO, it’s time to get serious about tax planning. 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.
Here’s how to get started:
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.
The tax consequences of an IPO can be overwhelming, especially if you’re managing RSUs, ISOs, ESPPs, and trading windows for the first time. 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 a tax advisor who understands IPOs and tech stock compensation can help you navigate this new financial chapter with confidence.
