Stripe (Yahoo Finance) announced its intention to IPO in July 2022. With the markets resembling something closer to a WWE wrestling match than the calm seas we’ve been used to over the past few years, we’re unsure when (and if) an IPO will happen.
But, while we wait, what tax planning can we do in the meantime?
How are NQSOs Taxed?
Before we consider tax planning opportunities, we need to understand how NQSOs are taxed. When you were hired, you may have received a grant of NQSOs with a 10 year window to exercise. When an RSU is exercised, it is subject to income taxes. Generally, shares are withheld to pay your income tax, Social Security and Medicare tax liability. You also receive the net amount after taxes in shares that you can do with as you please. Take a look at your paystub. You’ll notice an additional line showing the full gross value of your stock options as an addition to compensation. And, at year end, this amount is included in Box 1 of your W2 that is reported to the IRS.
The good news is, your company withheld taxes. The bad news is, they might not have withheld enough. The IRS requires companies to withhold a flat 22% Federal withholding on “supplemental income.” (Supplemental income is anything that isn’t straight wages, in this case commissions, bonuses AND stock compensation.) When you add this to FICA (7.625%) and State (let’s say 7%), this feels like a lot of taxes! But depending on your family’s income, your Federal marginal tax bracket could be up to 37%. This could lead to a 15% shortfall in Federal taxes. If you’ve ever had an unexpected balance due at tax time, this is likely the cause.
When you sell your NQSOs, you could be subject to tax again. But only if the stock price has increased from the date of vesting. If so, plan on 15% – 37% capital gain tax on the difference between the vest price and the sale price.
Tax Return in Year of Exercise
As a side note, you should double check your tax return filing for the year in which you exercised shares. There should be little to no gain on Schedule D in the year of exercise. UNLESS the company valuation (409A valuation) has changed between the exercise and sale date. If you see a huge gain, you’ll want to ensure the correct stock basis adjustments have been made.
What Tax Planning Opportunities are There for NQSOs?
There are two ways we can save on taxes: 1) Avoid them entirely (great, right?) or 2) Defer them until later.
Underpayment Penalties and Interest
Let’s start first on ways we can avoid taxes, and in this case penalties, all together. The IRS has strict rules around how much tax needs to be remitted throughout the year either through withholding or estimated payments. There are two safe harbors available:
1) 110% of your prior year tax liability
2) 90% of your current year tax liability.
Here’s a quick example: Let’s say you paid $5,000 in Federal taxes last year (we can wish…). Your safe harbor amount based on your prior year tax is 110% of $5,000 or $5,500. If your tax liability is projected to be $10,000 for this year, the IRS will allow you to use the lower safe harbor method of $5,500. As long as we meet the lower of the two numbers, you can avoid additional penalties and interest.
Deferring Tax Liability
Another planning opportunity would be to defer capital gains to a future date. We mentioned above how there is a second round of taxes due if your stock has increased in value since the vesting date. While there are only secondary market options to sell Stripe shares currently, now is a good time to plan on a potential IPO and increased liquidity. If you have been holding some of your NQSOs from earlier rounds of funding, these shares may have grown in value (at least based on the latest company valuation). If you’ve held the shares for greater than one year, you can use the lower capital gain tax rates of 15-20% instead of your ordinary tax rates. This is a not-insignificant tax savings!
You may also want to wait to recognize gain in a future year where your capital gains would be lower to overall lower family income. If you plan on taking a sabbatical, this can be an efficient strategy to lower capital gains from 20% to 15% or even 0% in some cases.
Also, if you are planning on moving to another state, with perhaps a lower tax rate (or none at all!), then you may want to defer capital gains to a future date to not only defer tax liability but eliminate some of it all together.
Regardless of your situation, now is the time to think about tax planning before a potential IPO. CPAs, EAs and tax professionals with experience in stock options are in demand and now is the time to get tax planning advice – before you think you need it.