Steps to Take When Anticipating an IPO

• Take inventory of what stock you currently own versus what your options give you the right to buy.
• Did you receive shares from your company outright; have you already exercised options?
• If you currently own stock, how long have you held it?

All of these factors will play into the strategy you develop with your financial advisor.

Restricted stock units (RSUs) are subject to different types of vesting. Understanding how any RSUs vest is imperative when developing your tax plan.

Single-trigger vesting occurs when a single event, such as time in service to the company, triggers the transfer of shares to an employee. This typically happens over a period of four to five years, and shares are taxed as ordinary income in the year that they vest. RSUs are included in an employee’s wages and are subject to withholding, which is typically taken through a reduction in the number of shares transferred. Often, however, withholding is not sufficient to cover the increase in income, so employees may benefit from increasing the withholding from their regular wages to compensate. In post-IPO companies, employees commonly cover the additional tax burden by selling some of their newly acquired shares; however, employees in pre-IPO companies lack this option.

Pre-IPO companies often use double-trigger RSU vesting to help protect employees from owing taxes on stocks that they won’t be able to sell in the near future. In this scenario, two events must occur before shares vest to an employee: both time in service and a liquidity event such as an acquisition or IPO. Even in the case of a double vesting trigger, however, employees often are unable to sell shares before taxes are due as a result of lockup periods and limited trading windows. This problem is compounded by the fact that all of the shares are delivered at the time of the second triggering event rather than over a period of years, creating a large bump in taxable income in a single year.

Understanding exactly when your RSU shares vest will enable you to plan for paying taxes on the income. This may involve increasing withholding from wages and/ or securing loans. In some cases, this spike in ordinary income may provide an opportunity to exercise and hold ISOs without incurring additional tax liability under the alternative minimum tax (AMT).

Stock options can be granted either as incentive (ISOs) or nonqualified stock options (NQSOs). ISOs can be granted only to employees and offer some tax benefits that the more common NQSOs, which can also be granted to contractors, consultants, officers, and directors, lack. A review of your stock plan to understand whether ISOs and/or NQSOs are part of your compensation is necessary in order to build an effective strategy for managing your tax liability.

Stock options convey the right to buy a specific amount of stock at a price (the “strike price”) that is based on its fair market value at the time of granting. If the stock price rises, the holder can still buy the stock at the strike price. When those options are ISOs, their exercise is, generally speaking, a non-taxable event. If shares from ISOs are held for at least one year after exercise and two years after the options are granted, then proceeds from the sale of shares are taxable as long-term capital gains rather than ordinary income. On the other hand, holding the stock beyond the year you exercise ISOs makes the bargain element (the difference between the strike price and market value at the time of exercise) taxable under the AMT.

Nonqualified stock options, on the other hand, create a taxable event at the time of exercise. When you exercise NQSOs, the difference between the strike price paid and the current fair market value is taxable as wage income. Unlike ISOs, NQSOs may be transferred to permitted recipients if your company’s stock plan allows it. Gifting of options to individuals, trusts, family limited partnerships, or charities can be part of an effective tax planning strategy for those who hold NQSOs. Because complex rules apply to such transfers, however, it’s important to consult with a financial professional who is familiar with the tax, accounting, and securities issues involved.

How you treat your stock options can have a profound effect on your tax liability.

For example, if your company allows it, exercising options early (before they vest) and filing a timely 83(b) election makes your shares taxable at the time of granting rather than at the time of vesting This can result in a lower tax bill should the event that the market value of shares increase after this time. It’s important to work with a tax planning professional who has experience dealing with the intricacies of stock options so they can alert you to such critical decision-making deadlines and guide you toward the most effective ways to minimize your tax liability

A financial plan is your roadmap to your goals. It lays out how you will fund your retirement, your kids’ college tuition, and the overall lifestyle you desire. The first step is to clarify what your specific goals are, and the financial plan should proceed from there. An experienced professional can be an invaluable asset for creating a tax-efficient strategy that’s carefully tailored to your goals, needs, and priorities.

Managing your investments with an eye toward tax efficiency is essential to making the most of your gains. Conventional wisdom says to buy low and sell high; however, selling shares that have decreased in value can be an important part of keeping your tax liability in check. The tactic of tax loss harvesting, selling shares at a low price and then replacing them with similar investments, can often be used to boost an investor’s overall return after taxes.

Make sure to work with an experienced and knowledgeable investment advisor when devising and implementing a tax loss harvesting strategy, as it’s not hard for a novice investor to run afoul of IRS rules in the process.

Avoiding or minimizing taxes when possible is important, but so is maximizing gains. A sound investment strategy—apart from tax considerations—is critical for building your wealth. Make sure you’re working with a trustworthy investment advisor who uses sound strategies to guide their investment advice.

Be aware of whether your advisor earns commissions, as this may influence the advice they give. Registered Investment Advisors (RIAs) who adhere to the fiduciary standard are required by law to put their client’s interests first when giving financial advice.

Brokers, on the other hand, must only ensure their recommendations are “suitable” for their clients’ needs. This can create a conflict for brokers who can earn a higher commission on an investment that may be suitable but less beneficial than one that earns a lower commission.

In investment management, a sales strategy is just as important to reaching your goals as a buying strategy. Careful timing of stock sales is essential for managing your tax burden as well as realizing healthy growth.

Additionally, sales planning is vital for managers and insiders subject to trading windows.

Stockholders can set up a 10b5- 1 plan while they’re not privy to material non-public information, allowing them to ignore blackout periods and make preset trades without fear of the appearance of insider trading.

Estate planning is an indispensable part of protecting your wealth. Especially if you anticipate having a large estate to pass on, it’s important to work with an advisor who is knowledgeable about estate planning strategies. Many tools are available that can allow you to transfer wealth to individuals and organizations you care about while keeping the size of your taxable estate under control.

Don’t wait until IPO day to start thinking about your stock options. The actions you take now can either expand or limit your ability to grow wealth over time and pass it on to those you love.