We’ve been helping our clients with tender offer tax treatment since 2017. Since then, we’ve seen tender offers happen way more often in tech companies. Basically, for tech employees, a tender offer is like an IPO before the IPO actually happens: It’s their first chance to exercise and actually sell their stock options… giving them a nice lump sum of cash to use. So… what should you do with that sum of cash from a tender offer? What are the smartest financial moves you can make to deal with taxes while building your future? We’ve got five ideas for you…
1. Pay Your Tender Offer-Induced Tax
Number one, always and forever, is to make sure your tender offer tax treatment bill is covered for this major cash injection. Not the most exciting thing, I know… but getting a massive unexpected tax bill feels terrible… not to mention dealing with an underpayment penalty fee. When you exercise and sell during a tender offer, it is a taxable event. The IRS will want their fair share. If you get ahead of the game now, you can avoid any possible underpayment fees and make sure you’ve got full peace of mind (and a full bank balance) when the tax bill comes. To start, gather the documents you’ll need to figure out how much you’ll owe from the tender offer exercise:
- Your transaction confirmation, which includes:
- Number of shares or options you sold
- Fees you paid
- Taxes the company withheld on your behalf
- A copy of your pay stub from the tender offer
On your pay stub, check to see how much your company withheld in state and federal taxes for you. If you did a same-day sale of non qualified stock options (NSO), it’s important to know that they’re subject to supplemental wage withholding rules, and your pay stub should show that 22% of your gross proceeds were withheld for federal taxes, and 10% for state. If you sold incentive stock options (ISO), your employer may not have withheld any income tax. If you sold shares from a past exercise of stock options, they probably won’t have tax withheld on them either. (So pay attention. ????) The good news is that some of your tax may be taken care of, but you’ll probably still have a balance due in April. Once you know how much tax has already been withheld, you can do a tax projection to figure out the rest of what you’ll owe. To calculate this, you’ll need a few more documents:
- Your last tax return
- Tender offer pay stub
- Regular pay stub
When you have these three documents (and the help of a tender offer tax treatment expert), you can calculate what your tax bill will be for the tender offer. As soon as you have that number, we recommend spending some of the cash from your tender offer to make an estimated tax payment to get that bill out of your way and avoid an underpayment penalty. (If you decide to not pay the full estimated amount, set aside the cash you’ll need to pay in April into a high-yield savings account.)
2. Exercise & Hold MORE Options
Managing your incentive stock options before, during, and after an IPO is a marathon. You may have a small victory now with selling in your tender offer, which is fantastic. It’s definitely a win worth celebrating. But you’ve still got a long road ahead of you, so it’s time to jog into the marathon’s aid station, get a drink of Gatorade, and reevaluate your strategy. If you haven’t exercised any ISO before, the tender offer is the time to start. Since your tender offer tax treatment increases your regular income, it widens the gap between your regular income tax calculation and your alternative minimum tax (AMT) calculation. ???? When this happens, it increases the number of ISO you can exercise and hold in the same calendar year as your tender offer, before you hit that AMT threshold. (Click here for a background on all things ISO + AMT.) It’s an incredible opportunity to exercise ISO, especially with the lump sum of cash you can get on the other side, and I’d hate for you to miss it. PLUS, a tender offer usually means you’ll see an increase in your company’s 409(a) value, which means it’s even better to exercise more ISO before the 409(a) increases.
3. Exercise More ISO in January
When I’m preparing my clients for an IPO, I like to get them into a routine. This routine involves exercising and holding ISO every January, like clockwork. ???? When you exercise ISO in January, it puts time in your favor. You get to hold onto the shares for over 12 months (qualifying them for long-term capital gains) before you owe the AMT the next April. This comes with two benefits: One, you can then sell some of your shares to cover the AMT bill. (This makes exercising your options more affordable.) Two, you have 11 months to rethink your exercise & hold decision: if you decide to sell those shares any time between February and December, they’ll be taxed based on the sell instead of the exercise, eliminating AMT altogether. (This also gives us a chance to keep an eye on your company’s value and your finances to make sure we make the best decision for you financially.) If you’re sitting on cash from a tender offer that happened in the last half of the year before, there’s nothing wrong with keeping it in a high-yield savings account until January so you can exercise more stock options.
4. Fund Your 1-3 Year Cash Needs
Look at your life goals: do you have any major expenses coming up? Do you want to buy a house? Get married? Have a child? Move to a different city? If so, keep the cash from your tender offer sale to fund these expenses: there’s no need to invest it. Investment returns take time, but investment losses happen fast. Don’t take risks with the tender offer cash you need: put it in a high-yield savings account until you need it, and spend it when the time comes.
5. Tender Offer Tax Treatment Done: Invest the Remainder of Your Cash
Yes, investing is last on our list. Why? Investing in the stock market is a long-term play, returns take a long time, and if you do things wrong, you can lose a lot of money fast. To start, go through items 1-4 above and assign dollar amounts for things you’ll need cash for: tender offer tax treatment, exercising more options, big expenses, etc. THEN (and only then) is it a good idea to invest the rest. I know investing a big, shiny lump sum of cash can be tempting… it’s what most of our clients want to do after their first big sale. But when you look at the bigger picture of your finances, it’s usually the thing that should be last on your list.
Use Your Tender Offer Cash to Navigate Tax Treatment and Advance Your Financial Goals
The main goal is to use the lump sum of cash from the tender offer to cover yourself tax treatment wise and to set yourself up for financial success. The choices we make with money are like building blocks, and each choice builds upon the one before. Plus, if you have clear financial goals and a financial plan, following the steps of that plan gets easier to do and solidifies your finances. If you’d like help creating our own financial plan, or if you want to talk to an experienced financial planner and stock options tax preparer, click here to book a call with a member of our staff.
