Top Tax Considerations During a Layoff

As Google, Microsoft, Amazon and Salesforce announce a new round of 22,000 layoffs, many are worried about their employment or have already been impacted by job loss. For those that have lost jobs, you certainly may not be thinking about tax considerations. Who could blame you? But there are some crucial tax considerations that you should analyze in the first months of a job loss when you’re holding equity compensation.

Equity Compensation Considerations

The tax impact of your equity compensation during a layoff will vary depending on the type of options and whether they are vested or unvested at the time of layoff. (When a stock option vests, it means that it is actually available for you to exercise or buy.)

Generally, once your employment ends, you will lose any unvested stock options. Some stock agreements can provide exceptions for certain events. Since layoffs could be one of them, you will want to check your agreements to review your company’s policy.

For vested Restricted Stock Units (RSUs), you’ve already received these shares and they will be available for sale in your brokerage account. You’ve already been taxed on these and they are yours to keep or sell.

For Nonqualified Stock Options (NQSOs) and Incentive Stock Options (ISOs), you may have vested, but unexercised options. In this case, the IRS allows for a short window of time (at least 90 days, but companies can provide more time) to decide whether to exercise the shares or abandon them. In order to exercise, you’ll need to have the cash set aside to pay the exercise price, unless the company allows for a cashless exercise (where they withhold shares to pay your tax liability and exercise price).

Smaller companies can often have clawback provisions that allow them the right to repurchase your shares (even exercised shares) at the prevailing market rate at the time of separation. You will find this language in the option agreement that you signed and can vary quite a bit among companies. Review your agreement for more information.

Severance Pay

If you receive severance pay from your employer, it will be considered taxable income. It’s important to note that severance pay is withheld at 22%. If you’re in a higher tax bracket, you may find you have a balance due when you file your tax return. Setting aside some of the cash (if you can) is a smart idea to avoid tax season surprises.

Unemployment Benefits

Unemployment benefits are also considered taxable income. States typically don’t withhold ANY taxes. So it’s important to keep this in mind and do your best to set aside money for taxes. You will receive a 1099-G tax document next January that will be needed for your tax filing.

Retirement Plan Distributions

If you are laid off, you may be considering a distribution from your retirement plan. If so, it’s important to consider the tax consequences. Retirement plan distributions are often subject to two levels of taxation: income tax and early withdrawal penalties.

IRA custodians will often allow you to withhold a flat amount of your distribution for taxes. However, they rarely look at the entire tax consideration of such a move. For instance, they might offer to withhold a flat 10% (presumably to cover the early withdrawal penalty), but your actual effective tax rate on the withdrawal could be as high as 57% when taking into account federal and state income taxes & penalties.

Before scheduling a withdrawal, take inventory of the types of retirement funds at your disposal. Withdrawals from after tax contributions (Roth IRAs) have very different tax considerations than withdrawals from a pre-tax, Traditional IRA.

If you’re unsure of the rules, be sure to check out the IRS frequently asked questions as well as potential exceptions to the early withdrawal penalty.

Summary

These are just a few of the tax considerations to keep in mind when you are laid off. If you’re unsure how to plan for tax considerations during a layoff, be sure to speak with a tax professional to avoid tax mistakes.