One big reason the tech industry attracts a lot of talent: you get partly compensated in stock, and if you’re early enough at a company that IPOs, your stock options or RSUs can make you a millionaire multiple times over when the company goes public.
Google created >1000 millionaires at IPO. Facebook too. Microsoft has created >10k millionaires. Amazon probably even more.
But with stock compensation, your taxes can quickly get complicated. You need thoughtful tax planning to make sure you don’t pay more in taxes than needed. As with other types of income, what matters isn’t what you earn – it’s what you keep.
So this week, I spoke with Shane Mason, whose CPA firm specializes in advising entrepreneurs and tech workers, to share tips and strategies on stock option and RSU tax planning.
- The different types of stock-based compensation and tax regime applicable to each
- Deep dive on Incentive Stock Options + AMT + AMT “refund” rules
- How an 83(b) election works, and pros/cons of doing it
- Key tax planning strategies applicable to stock compensation (e.g. timing strategies, optimizing tax buckets)
Do you earn stock-based compensation? What tax planning best practices have you followed? What do you want to know more about when it comes to stock tax planning? Let me know by leaving a comment.
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Andrew Chen 01:23
My guest today is Shane Mason.
Shane is a CPA who specializes in helping entrepreneurs and tech professionals with tax and financial planning, particularly stock option tax planning.
He worked for a number of years at large national accounting firms before co-founding his own CPA firm, Brooklyn FI.
I invited Shane to the podcast this week to share tips and insights about tax planning when it comes to stock options and stock-based compensation. This will be particularly relevant to folks who earn a material part of their compensation in the form of stock – as is the case for folks who work in the tech industry, in startups, early stage businesses, or even large-cap tech companies.
Shane, thanks so much for joining us today to chat about this important topic!
Shane Mason 02:04
Thanks, Andrew. I’m happy to be here.
Andrew Chen 02:06
I’d love to start just by learning a little bit more about your background. How did you get into specializing in tax planning for tech professionals and folks who earn a large portion of their income from stock compensation?
Shane Mason 02:20
I started my career at PricewaterhouseCoopers in Austin, Texas back in 2010. It feels like a long time ago. We were working with tech companies in the area.
Austin has a great tech scene. I was working in the tax department there, helping out technology firms file their tax returns, etc. And part of that was dealing with the options that they were granting to their employees, writing off those options as expenses, and getting to understand non-qualified incentive stock options, RSUs, restricted stock.
I did that for about three or four years, and then moved up to New York and worked for a mid-sized firm where we flipped the script, wherein I was actually filing the tax returns for the recipients of the grants instead of the companies that were issuing them.
I was working there for about three years and started moonlighting on the side about halfway into it, realized that most of the value that clients get out of a relationship with a CPA really comes from advisory and not just filling out forms.
So I got my CFP designation in 2015, and started moonlighting and providing equity compensation and advice on the side. Back then, I realized that you really can’t do that on the side. It needs to be a full-blown, all-in relationship because of how volatile equity compensation is, and how hands-on it needs to be.
I started Brooklyn FI in late 2017 with my business partner. 2018 is where we had our first really getting off the ground after that tax season.
It was over in 2018, and hit the ground running. We’ve been doing it for about 3 ½-4 years now, just all-in on the tech niche. And the rabbit hole just keeps going deeper and deeper as we’ve discovered we’re having a lot of fun with it.
Andrew Chen 04:05
Yeah, it’s a growing industry. Thanks so much for the background.
I’d love to just dive right in. Can you help us understand: what are the different types of stock-based compensation, the range of stock-based compensation out there, and the tax implication and basic tax regime that applies to each one?
Shane Mason 04:24
There’s a lot of different types of equity comp. There’s a lot of outliers. We’re niche ones.
But it helps to start with the general framework of there being four main types of equity comp. And you can even split those four into two different types amongst those four.
There’s what’s called full grant awards where you just receive a full share award. The two of those are restricted stock units and just restricted stock.
When those vest, you receive a share. It’s just that simple. It can get more complicated if there’s limitations.
They’re called restricted for a reason: because there’s vesting related to them, and that can get quite complicated. And there’s 83(b)s, which we can talk about later. But at the end of the day, those two types of awards, when it vests, you receive the whole share.
The other two are options. They’re not full share awards, but you receive the option, which requires one more step in the process, and that is, to exercise that option.
The option can vest, but all that has vested is not the full share. It’s the option to purchase that share at a specific price.
And those two types of awards are non-qualified stock options (or just really regular stock options is another way to think about them), and then there’s what’s called incentive stock options which qualify for certain advanced or special tax treatment.
That’s why the other ones are called non-qualified stock options: because they don’t qualify for that special tax treatment, which we can dig into. I don’t know how deep you want to get into the weeds on each of those four different types.
But generally, the taxation principles of them are that whenever something vests for full share awards, the restricted stock or restricted stock units, whenever those vest, typically the value of those shares on the date of the vest are taxable in income, and they will show up on your tax documents, whether that’s a W-2 or a 1099.
Whereas with options, the taxable event is actually when you exercise them, not the vesting. And the size of the taxable event is dependent upon the difference between the strike price (what you pay for it, essentially) and the value of the share when you exercise. The difference between those two things is what’s going to show up in your income in that year.
Andrew Chen 06:42
Awesome. I’d definitely love to get into the nitty-gritty details. The options one is going to be a little bit more complicated, so maybe start with the RSU one and the restricted stock one.
First, can you help us understand the difference between RSUs and regular restricted stock? A share is a share. What is the difference?
Shane Mason 06:59
Generally, it’s helpful to think about when companies decide to grant these types of things as well. I wish I could have had a visual here. Whenever I teach other advisors about equity compensation, I use a visual and it shows, at the beginning, at the founding, typically it’s restricted stock.
That usually goes to the original owners of the company, like there’s three people sitting around and they’re deciding how to incentivize everyone to stick around to build equity in a startup. And that’s usually with restricted stock. It will say, “You get 33% of the company, but it has to vest over three years.”
So, it’s stock that is restricted by you actually performing services for this company. If you stop doing that, then you don’t get the stock. That is restricted stock.
Typically, that’s where people hear about 83(b) elections. With a restricted stock, when it vests, it shows up in your income at the time that it vests. With 83(b), you can accelerate all that income into the current year, and that’s really valuable if the stock is currently worth nothing.
Whereas three years from now, when it vests, your company could be a unicorn at that point, if you’re very lucky, and one-third of your company vesting, and multimillion-dollar, maybe tens of millions of dollars, showing up in your income at that point in time is not a good thing. So, 83(b) elections are almost always, 99% of the time, a good idea.
At the beginning, there’s restricted stock. At the other very end of the spectrum, when a company is typically public is when you get RSUs.
RSUs are a tool that allows public companies to say, “These RSUs are going to vest over the next four years, and when they do, they show up in your income. They’re going to show up in your W-2.”
And it’s very easy to value them at the time of the vest because we’re a public company at that point. Because if we’re traded on the stock exchange routinely, because we’re public now, it’s easy for us to show you the value of this company.
Whereas with a restricted stock, it’s way before there’s any valuations. Usually, the value of that company is only updated once or twice a year. If they’re going through a series raise, a third-party valuation company comes in and values that company.
So, restricted stock is usually at the very beginning. Restricted stock units are typically just before they go public. Maybe they’re Series C or D or E or on down the alphabet, and they’re heading towards an IPO.
RSUs are very popular with post-public companies because of their ease of use.
Andrew Chen 09:29
Makes sense. It sounds like restricted stock is really applicable to the founders. If you’re not a founder, you’re probably looking at either options or RSUs, is that correct?
Shane Mason 09:37
Yeah, that’s typical. There’s exceptions to every rule.
In between the public and the founding, there’s typically a lot of incentive stock options and non-qualified options. ISOs typically come first, and then non-quals come after that.
Andrew Chen 09:50
Makes sense. If the company is not public yet, and they’re just doing their periodic 409A valuation, is that the value that you would be using at grant or vesting date for purposes of computing your tax liability?
Shane Mason 10:08
Yeah, exactly. If someone is familiar with the jargon word “409A,” within the Internal Revenue Code, it references how the IRS is going to value the difference between the fair market value and the strike price: that’s your taxable income pre IPO.
Post IPO, the 409A is no longer applicable because it’s on the stock market. So, that’s the value that you’re going to use.
Let’s say you’ve got some options you want to exercise. You’re going to pay x amount for them, and y is the value.
You’re not publicly traded. You’ve got to figure it out. Since you’re not public, there’s usually an accounting firm or a valuation firm that comes in and says, “Hey, pre-IPO company, this is your 409A valuation, which is x amount per share that your employees can use.”
“This is what we’re going to report to the IRS when your employees exercise shares.” So the IRS knows how much income that you’re going to experience.
Andrew Chen 11:09
Yeah, I remember I worked at a past company. They’ve got RSUs. It was not public yet.
And because the value of these companies can change actually quite drastically, even in a six-month time period, you’re doing a 409A valuation quarterly or twice a year. If your timing is right, does that mean you can end up getting a valuation that’s quite low compared to what the reality is when you actually join the company?
Shane Mason 11:34
Yeah. We’ve seen 409A valuations 100x over the course of a year or two.
Within the context of you want the 409A to be sky high for economic reasons, for when you actually go to sell the shares, or for your personal net worth, or for tax reasons, you want that 409A valuation to be as low as possible.
Especially if you are in a rare company where RSUs vest pre IPO, most RSUs now have a double trigger vesting wherein you vest over a period of time, but also the company needs to be public for that to vest double trigger at the time.
But the 409A, you want that to be low because that’s going to show up in your income. Or if you’re exercising options, you want the 409A to be very close to your strike price, so that there’s not much of a taxable event.
And then, in a perfect world, if you time everything perfectly, it immediately shoots up. The 409A shoots up after you’ve exercised, so your taxable issues are less of a problem.
Andrew Chen 12:35
So, whether by luck or by skill, you could time it in such a way that your tax liability is actually quite low compared to the economic value of the shares. Is that right?
Shane Mason 12:46
Yeah. If you’re close to management, the things that typically increase the 409A valuation are around a series raise.
If you’re Series B and your 409A is $5 a share, and for some reason, you know that a series, they’re going to raise some more money. That’s typically where a 409A will jump up quite a bit. It doesn’t always work that way, but it’s typically one of the things that will change a 409A valuation.
Andrew Chen 13:13
I guess when it comes to restricted stock units, you’re just imputed ordinary income at the vesting date. And then, after that, it’s just short- or long-term capital gains. Is that accurate?
Shane Mason 13:31
Yeah. I had mentioned earlier that there’s only one event that really happens with restricted stock units. That’s actually not true.
There’s only one event to get your shares, but we’ve got to remember, you’ve got to sell those shares at some point in the future. To your point, the income shows up as ordinary income on your W-2 when the RSUs vest, and now you have the share.
So, what do you do with that share after you own it? Do you hold on to it, do you try to get long-term capital gains on the sale of that share, or do you just go ahead and sell it?
Our policy at Brooklyn FI, when we talk to our clients, is that we sell it right away. Typically, if you have RSUs, in any company, you have a concentrated position in that company. If more than 20% of your net worth, of your portfolio, is made up of that one company, then that’s a concentrated position.
It’s something that we need to get you out of. Traditional financial advice requires diversification. It’s the only free lunch in the financial planning space.
So, if you’ve already paid taxes on that RSU share because it showed up on your W-2, we’re not going to wait a whole year just for the fluctuation in that one stock to potentially get long-term cap gains.
Let’s say, for example, that I vested $100, even if it goes up to $120, if it experiences great 20% growth, you’re only getting a long-term cap gain treatment on the $20 difference. So you’re really holding on to a concentrated position for a whole extra year for preferential tax treatment on 20%, if you’re lucky.
Sometimes it will go down in value, and your capital losses are limited to only $3000 per year. If it dips quite a bit, it only helps your taxes quite a little.
Andrew Chen 15:20
Let’s shift to options. Help us understand the tax regime, how it works in some detail, for both non-qualified and incentive stock options.
Shane Mason 15:30
I’ll start with non-qualified stock options because they’re simpler. Incentive stock options is probably another podcast, but I’ll do my best to squeeze that in as well.
Non-qualified options are quite similar to RSUs in that when the taxable event does happen, they will show up in your W-2 and they will be subject to ordinary income tax rates, just like your wages are. They will also be subject to not just ordinary income taxes, but also Social Security and Medicare taxes as well. That will be withheld as well.
The way that we figure out the value that is going to show up in your W-2 is we take the difference between the fair market value and the strike price.
To use a concrete example, let’s say that the fair market value, if it’s a public company, it’s obvious, is $25, or if the 409A is pegged to $25 for a period of time, and your strike price is $10.
You have to come up with $10 in cash for every option that you want to exercise (let’s say that’s 10), so you pay $100 for those shares. And then you’ve got your $15 of value per share ($25 minus $10).
That’s going to be the value times 10 that shows up in your W-2. I hope I got that math right.
Andrew Chen 16:46
Yeah, it makes sense. Just to be clear, you get the shares awarded, say, shortly after you start working there. When you vest, you’re vesting the right to buy the share.
If you decide to exercise, then you would buy at the strike price. In your example, that’s the $10. So you fork over $10 per share to the company, and then you now own stock in the company.
That stock is theoretically worth, in this example, $25 because that was the most recent valuation. So your gain (not a cash gain, but a paper gain) is now $15 per share. I think that’s called the “bargain element.”
Shane Mason 17:25
Andrew Chen 17:26
And that is what you are going to be taxed on at ordinary rates, correct?
Shane Mason 17:31
So you have just paid money to pay tax.
Andrew Chen 17:35
Shane Mason 17:36
So, buying your options is actually typically something that people that already have money, or that are very non risk-averse, or are friendly with risk, do. And the payoff for that is if that $25 per share company goes in IPOs in three years, and now it’s $150 a share, then you have taken risk for great reward.
Andrew Chen 17:58
Yeah, and you obviously earn all that back. But just to be clear, when you exercise, you paid $10, and then no good deed goes unpunished. Now you’re going to pay tax on $15 per share because you theoretically have that gain, even though you don’t have the cash in your hand.
Shane Mason 18:12
Exactly. In the IRS’ mind, you gave your friend $10, and your friend gave you $25 back, so $15 of income has just occurred.
Andrew Chen 18:22
Right. And then, after that, I think the tax regime should be very similar to RSUs, right? After that, it’s just based on short- or long-term capital gains when you sell, if you can even sell.
Shane Mason 18:33
Exactly. So, at that point, with a lot of our clients, we have them exercise their shares, their non-qualified options, and then immediately sell the shares because they’ve paid the tax on it at that point already.
Andrew Chen 18:46
You would just do it in a secondary market or something?
Shane Mason 18:49
If they’re pre-IPO, yeah. If a secondary market does come up, and we have an opportunity to take some risk off the table, we do often recommend that they go ahead and do that.
Andrew Chen 19:01
So then, the complicated one: incentive stock options. This one gets gnarly with AMT and all these others.
Can you help us walk through somebody who is reasonably familiar with how to do their finances and how to do their taxes? Help us understand the broad strokes of how the tax regime here works.
Shane Mason 19:19
Just to start off, I think I can simplify this a bit. But for those of us listening to this, and they have, say, $50,000 of gains available, “bargain element” that we’ve mentioned before, they should have a tax advisor.
You should talk to somebody before you do this because it can get messy, and it’s a multiyear issue. Even if you just have a good tax preparer that knows what they’re doing in the equity compensation space, it could save you a lot of money.
One time, we had seen a client that didn’t know what they were doing, they worked with a CPA that didn’t know what they were doing, and then they TurboTaxed it the next year, and they just didn’t know how to pick up a $50,000 tax credit. And that would have been wiped away if we hadn’t found it when we eventually did their taxes years later and amended old returns.
Let me explain, and then you can see why I’m even mentioning that. The difference between ISOs and non-qualified stock options is the bargain element that existed before in non-qualified options, the $25 minus $10, that $15 that shows up in your income and on your W-2, that doesn’t happen for incentive stock options.
When you exercise those, they don’t show up in your income. They’re not subject to ordinary income taxes. They’re not subject to Social Security and Medicare, which is great.
If you satisfy certain holding requirements, you have to have held the stock from two years from the time it’s granted to the time you sell it, and you also have to have held it one year from the time that you exercise it to the time you sell it.
Andrew Chen 20:51
On this one, I just want to sidebar here. If you do the math on that, if you just exactly meet those requirements, and typically for a company, I think that means you would have vested your first tranche, and then by the time the second year finishes, you’ve qualified for long-term gains. Was that the intention of this rule to make it that way?
Shane Mason 21:18
I would wager that it is. I haven’t spoken to the senators.
I don’t know when incentive stock options were invented, honestly. I think it might have been in the ‘90s. The Tax Foundation would probably be a good place to figure out why.
I love to get into the whys that certain things were created in the tax code. But if you look at the rules surrounding it, it looks like it’s intended for people to stick around. If you stick around at a company, you have to be there for two years to qualify for special tax purposes, special tax provisions.
So, it looks like the intention was to keep people working at these companies, especially people that started at the company quite early, because there’s a cap on the value that can be awarded to each of your employees. And once the company is too big, it’s really hard to even offer incentive stock options.
So, it’s really for those early employees to keep them around to build new companies. We’re in entrepreneurship here in America. The fact pattern lines up with all of those intentions.
Andrew Chen 22:20
What is the cap? I actually didn’t know about that.
Shane Mason 22:24
It’s $100,000 in value of the company. It’s a little tricky. We’ll have to put this one in the show notes because we could spend some time on this one.
Your company should tell you if they’ve given you too much value in incentive stock options. The internal accountants will handle that.
Andrew Chen 22:46
Interesting. So, when people join promising startups for options, they’re trying to do the math to say, “Okay, this could eventually translate into multiple millions of dollars.” But they’re doing projections, of course, based on their belief about where their company would go.
But it sounds like on paper, at that moment that they’re granted the value of whatever they’re granted, it’s not allowed to exceed about $100,000. Is that correct?
Shane Mason 23:20
The thing about that is that typically when you are granted options, the strike prices equal to the 409A, so that the valuation at that point is zero. Because if the strike price is equal to the fair market value, then it’s worth nothing.
Andrew Chen 23:39
I see what you mean. Got you.
Shane Mason 23:45
So, if we’re advising a client and they have $100,000 of non-qual (100,000 shares, and they have a strike price of $1), and their non-qual is in ISOs, we would always take the ISOs. ISOs are just worth more.
If you disqualify an ISO, like if you don’t meet the holding requirements, it just becomes a non-qualified stock option. That has not as good tax treatment.
Sometimes we tell our clients just to disqualify them because maybe they’re already so rich, it doesn’t really even matter that much, or 99% of their portfolio is made up of one stock. We’re more worried about getting risk off the table than saving 15% on that specific tranche of options that they hold.
Andrew Chen 24:34
True. And it sounds like you can’t be in the black more than $100,000. Is that right?
Shane Mason 24:40
In the black, as in the company…?
Andrew Chen 24:45
There can’t be existing bargain element that’s awarded to you at the time of grant that’s more than $100,000. Is that what you’re saying?
Shane Mason 24:54
In the years that I’ve reviewed grants, and we’re talking about millions of shares, I don’t think I’ve ever seen it. I know that it is possible at a 10% discount on ISOs.
Technically, if they’re awarded at the right time, the strike price can be mildly lower than the fair market value at the time of grant. I’ve never seen it.
Andrew Chen 25:18
Is what you were referring to about the $100,000 cap?
Shane Mason 25:21
No. I think that the $100,000 works. And this is something that is always handled internally at companies, so I don’t ever have to do the math.
But I think it’s literally the math that I just came up with you earlier: 100,000 shares at $1 strike price. If it was 105,000 shares at $1 strike price, 5000 of their shares wouldn’t qualify. But I don’t have to think about that very often.
Andrew Chen 25:43
So, the two-year holding after grant, one year after exercise, and then what happens?
Shane Mason 25:56
If you meet the requirements, I told you earlier, to circle back, the $15 of bargain element, if you exercise that share or that option, you now receive a share, and that does not show up in your ordinary income tax, Social Security, or Medicare taxes. Where it does show up is in the alternative minimum taxable income.
Just to give some background on what that is, within the United States, our tax system is obviously quite complicated. There’s a lot of deductions available, a lot of credits, etc. that wealthy people use.
It’s mostly for wealthy people, to be honest. They use it to minimize their taxable income and pay lower taxes.
In the ‘80s, Congress came up with the alternative minimum tax. It’s actually quite simple, if you think about it.
They just say, “Here is your tax before all those deductions. Add all that stuff back. All those preferential tax treatment items, add it all back.”
It’s pretty much a 28% tax on that income after it’s added back.
One of the main things that are added back, it’s funny if you look at the list of all the add backs. It’s like intangible, drilling well costs that we’re deducted: giant state and local income taxes, and a bunch of other life insurance things that your average American has never heard of.
Andrew Chen 27:09
Never going to encounter. It’s basically a second tax regime, totally separate, just designed to make wealthy people pay their fair share. Is that the mental shortcut?
Shane Mason 27:19
Exactly. It runs in parallel at all times. Everyone listening to this podcast has been exposed to the alternative minimum tax at one way or another, but has probably not paid it because it runs in the background.
Your TurboTax runs it. Your tax preparer always has to look at it to see if they’re subject to it. Most of the time, most people’s regular tax exceeds this alternative calculation.
You only pay the alternative minimum tax if, after running that calculation, it exceeds your regular tax, and you pay the difference between the two.
One of the main add backs that our audience is probably worried about, or one of the preferential tax treatments that I just mentioned, is that when you have that $15 bargain element that doesn’t show up in your income, you give your friend $10, he gives you $25 back, you get that $15 delta, that is a preferential tax thing.
Typically, that would have shown up in your income. But because it’s a qualified incentive stock option, it didn’t. For AMT purposes, we don’t get that exclusion, so it’s added back into alternative minimum tax.
Let’s say your alternative minimum tax calculation is $40,000 of alternative minimum tax, and your regular tax did not include that income (it’s $35,000), you will pay the difference of $5000 as additional alternative minimum tax on top of your regular tax.
Andrew Chen 28:42
Makes sense. So it might subject you to AMT. It might not.
You have to do the math. It also probably depends on how much you’re exercising, how big the bargain element is worth, and all those things. That’s the part you should probably consult a CPA.
And then what happens? That’s not the end of the story.
Shane Mason 29:01
No. Unfortunately, it’s not the end of the story. But it’s a good thing that it’s not the end of the story, actually.
You’ve exercised your shares. To make the math or the narrative a little bit easier to digest, let’s say after you have a big bargain element, $100,000 of bargain element goes in your alternative minimum tax, and you pay $15,000 of AMT, because your regular tax was $30,000 and your alternative tax was $45,000, so $15,000 is the excess. That’s what you pay in AMT that year.
Now, the cool thing to me is that the tax related specifically to those incentive stock options, you get as a credit in the future. Because if you paid tax on those options now, here’s the thing: later on down the road, you are going to sell those shares and you’ve paid a higher tax on those shares now, and you exercise them, so there’s a second event down the road wherein you will sell those shares.
Long story short, to prevent double taxation on the exercise and then the sale, you are allowed a credit in the future for any AMT that you pay now because you’ll pay also tax on them later. We don’t want double tax on these shares, so you get a credit that you get to carry forward to future years.
And any year in the future where you have a flip-flop of what you’ve experienced in the year of exercise, in future years, if your regular tax is higher than your AMT, like most normal Americans, you get a credit down. Your regular tax gets to come down to your alternative tax.
Let’s say the year after the exercise, your regular tax is $40,000 and your AMT is $35,000. That’s a $5000 difference. Of your $15,000 of credit that you carried forward, you get to take $5000 of that back as a credit in that year, and then you have a $10,000 carry forward to the next year.
Andrew Chen 30:59
You can always only take the difference between the two, and then you have to amortize it over time?
Shane Mason 31:03
Yeah, you would only get the difference between the two. Let’s say if it was the same difference for the next three years, you would get $5000 of credit over those next three years.
Or, for whatever reason, in year two after the exercise, there’s a $10,000 difference, it would only last two years. You get $5000, and then $10,000, and then you’d be done.
That’s why I recommend people that are dealing with that specific type of issue deal with a competent preparer because you’ve got to keep track of that thing. We call that a paper asset, something to watch out for. We’ve seen people lose it, just leave it off the returns in future years, and it’s $50,000.
Andrew Chen 31:37
Yeah, of course. And the IRS isn’t going to come tell you about it.
Shane Mason 31:42
No, they do not remind you that you have access to this credit.
Andrew Chen 31:46
If you just self-file in TurboTax, though, and you’re doing it year by year, and you’re importing last year’s taxes to begin this year’s return, wouldn’t TurboTax pick that stuff up for you?
Shane Mason 31:55
I think so. The problem is where a taxpayer forgets to even report the incentive stock options on the return because it’s on a special weird tax form called a 3921, or they switch preparers, like they go from TurboTax to a professional, and that professional doesn’t know about the credit, for whatever reason.
Because it’s a pretty niched thing. Anyone on this podcast dealing with ISOs, you’re in a niched space. You’ve got to work with a niched type of accountant if you’re going to deal with that, or financial planner as well.
Andrew Chen 32:27
One thing I’m curious about, and I’m going to try to not make my brain explode here. You pay AMT first at 28%, and then later, you get the credit back, but if it’s long-term gains at that point, you’re getting taxed at 15%-20%.
So you’ve paid 28%, but you’re crediting back at 15% or 20%, which ultimately just means that you have to amortize over a longer period of time. Is the government basically getting a little bit of a free lunch in that spread?
Shane Mason 32:59
No, actually. Taxes suck, and they’re really complicated, so let me debunk a myth on that.
The credit is not against specifically cap gains tax. It’s just against your tax in general. The way that the tax works is that the tax on your line, on your tax return, is a combination of cap gain tax and regular tax.
Andrew Chen 33:29
So it goes against your blended rate.
Shane Mason 33:31
Yeah. So it’s just raw tax. But it actually does come back to you.
Andrew Chen 33:38
But then, like most people’s blended or effective rate, it’s going to be less than 28%. You need a lot of income for the blended rate to hit 28%.
I guess it means that maybe you have so much income that you can just take all the credit in a year or two. But if the diff between AMT and regular is fairly thin, then you might be spreading that out over more years.
That’s what it seems like. Is that the right way to look at it?
Shane Mason 34:03
Yeah. Here’s the way to think about it.
Let’s say that you’re paying it at 28%, and then, in the future, you’re only at a 10% tax rate. It’s going to take you longer to eat it up because you paid at 28% and now you’re recovering it at 10%.
But you’re in a lower bracket. That’s good for you.
Let’s say you’re in a higher bracket in the future, like “Yay! We get to recover more of the credit faster.” But you’re in the top bracket.
Another thing to debunk is that the recovery of the tax credit is not necessarily tied to the sale of those shares. You could exercise those shares and acquire them, pay the AMT, and then not sell them 10 years later, but you could have already recovered your credit by then because the mechanics of it are, simply, when the AMT is lower in the future than your regular tax, that’s when you recover the credit.
Andrew Chen 34:56
I see. That’s quite nice, then, because it doesn’t require you to artificially sell the shares if you didn’t want to. It’s just whenever your regular tax exceeds AMT.
Shane Mason 35:08
Yeah, but why are you holding those shares for 10 years anyway? You have a concentrated position in a company. You’ve already qualified for long-term cap gains rates.
Andrew Chen 35:17
You’d have to be really bullish that it’s Amazon, basically.
Shane Mason 35:21
Yeah, the past performance has no guarantee of future results.
Andrew Chen 35:26
Shane Mason 35:27
If you’re bullish on your shares, then please go for it. But my job is to take you through the gateway of financial independence with the least risk possible. Most of the time, that involves selling the majority of your shares within 3-4 years after.
Andrew Chen 35:43
Makes sense. For ISOs, after you exercise, there’s this AMT calculation, and you may get taxed at that point and then carry a credit forward. And then later, when you sell, if you’ve met the holding period requirements, then for regular tax purposes, all of the gain from the exercise price to the sale price would all be considered long-term capital gains in the regular tax regime, right?
Shane Mason 36:19
Exactly. Whereas, if they were non-qualified options, that bargain element at the time of exercise would have increased, you’d have paid ordinary income tax on that, and then it would have increased your basis. So the only thing available for long-term cap gains would have been the difference between exercise plus whatever you paid ordinary tax rates on: the $25 in that case.
Let’s say in our earlier example, that $15 of bargain element, you’re up to $25, and then down the road, you sell it for $50. You would only get long-term cap gains on the difference between $25 and $50.
Whereas, in the ISO exercise, the long-term cap gain difference between $15 and $50. You would get a lot more of that income subject to the lower cap gains rates.
Andrew Chen 37:12
Yeah. You basically get the bargain element at capital gains rates instead of ordinary rates.
Shane Mason 37:16
Exactly. If I got the math wrong, then that’s the principle there.
Andrew Chen 37:20
That’s all well and good if you meet the holding period rules. What happens if you don’t meet the holding period rules?
Shane Mason 37:30
That’s what’s called a disqualifying disposition. That’s where things can get messy, especially if somebody has left the company that they used to work for.
Because, let’s say, you exercise a bunch of shares right before you leave, and that’s typical because you have to exercise your shares within three months of leaving your company because they’re going to expire. If you don’t exercise them within three months of leaving, most of the time, then they just expire.
If they’re worth anything, it’s free money, so most people exercise. But then anything can happen.
You could want to buy a house now instead of later. You don’t want to wait for the holding period, or the company’s valuation has gone down and you want to sell before it goes even further down, whatever comes up.
You sell the stock before you hold it for a full year after exercise. That’s what’s called a disqualifying disposition.
That disqualifies them from incentive stock option treatment back to non-qualified regular stock option treatment, which means that your income is subject to ordinary income tax rates instead of long-term cap gains rates. It’s also subject to Social Security and Medicare. Any of those types of income need to show up on a W-2.
Where it gets messy is that you don’t even work there anymore, and you are supposed to tell your old company, “Hey, I disqualified these shares from when I used to work there, so please issue me another W-2.” It’s even weirder if you haven’t worked there in that tax year.
That’s often where we as advisors often have to say, “Here’s what happened. You need to go back to your old company and tell them to issue a tax document.”
The tax documentation surrounding equity compensation is surprisingly messy. We have had to override millions of dollars of cost basis information, probably tens of millions of dollars.
This is May of 2021. We just went through tax season for about 400 individuals. There’s probably millions of dollars of taxes that we saved our clients because we overrode the tax documentation to be the accurate amount.
It’s really, really messy. If you’ve got large equity compensation awards, and your CPA is just a regular CPA, or your tax person is a regular person, doesn’t niche into this, I strongly urge you to get a second opinion on what has already happened, because the documentation from E-Trade, Shareworks of Morgan Stanley, AST, Computershare, all of them are often incredibly wrong.
Because they’re not also the payroll provider, so that they don’t know that the income already showed up in your W-2. Then the 1099 needs to be overridden when they report it to the IRS and say, “We already paid tax on that. I don’t want to pay it again.”
Every time I make those adjustments in a tax return, I’m like, “Good God, this system is so wonky that there’s definitely thousands, tens or hundreds of thousands of taxpayers in the U.S. that are paying too much in tax because they don’t know about this.”
Andrew Chen 40:22
So, just to be clear, where does the gap arise between, say, what a Computershare provides you versus what the company would provide you? Because if you exercise shares at whatever scenario where a Computershare would effectively be wrong, there’s nothing for the company to withhold in taxes on your behalf. So I’m just trying to understand how a Computershare report or tax form that they send you…
Shane Mason 41:09
How it could be wrong?
Andrew Chen 41:10
Yeah, how it could be wrong, basically.
Shane Mason 41:13
Well, you’ve got to remember you’re dealing with small companies often, and small companies don’t have the most money to deal with administrative stuff. And then you’ve got the company playing a game of telephone between the payroll company and the custodian. Those are three different entities.
The custodian, their main job or their niche is to administer stock plan, and they don’t always talk to the payroll provider, which is on the other side of the company in the middle. So, if there’s not a good stream of information back and forth between those three people, then the documentation is just going to be wrong.
Sometimes there are not even tax documents relevant to these transactions, and they need to just be manually reported to the IRS. I know it sounds crazy to think that all of these tax documents are incorrect, but I see it every day.
Andrew Chen 42:03
So, a Computershare reports to you a tax form that says, “You have this much bargain element because you paid this much and this is what the fair market value is.”
Shane Mason 42:15
They don’t do that. The custodian is mostly related to the actual equity sales, so they will deal with the sale of the stocks. That’s what they deal with.
What a custodian will do is they’ll say, “We’ve created an account for this employee or this company. They’ll have these awards that will vest over the next four years.”
So they will tell the employer, “Here’s what’s now vested. Here’s what’s available to exercise.”
And then, if they exercise a share, they know that that client now owns that share, but they don’t know what shows up in the payroll system over here. Sometimes they don’t even know if they’re non-qualified or incentive stock options. All they know is that that client now owns that share.
They don’t know what’s gone into their W-2 already because that’s two entities over. That’s the payroll company. That’s not their problem.
And then, when the client sells that share, or that employee sells that share, all they know is what the person paid the custodian directly to acquire it. They know that they paid $10 for it. They don’t know about the $15 of bargain element that already showed up in the W-2 at the payroll provider.
That’s someone else’s problem. All they report to the IRS is the $10, not the $15 as well that showed up in the W-2.
Andrew Chen 43:29
I see. So then, as you, as Joe Taxpayer comes along, you take the form from Computershare, and you’re like, “I guess this is my gain.”
You punch in that gain, and then you take your W-2, and you’re like, “I guess this is my taxable income,” not knowing that they’re overlapping dollars.
Shane Mason 43:42
Exactly, paying double income tax on all of that bargain element for non-quals, and for disqualifying dispositions, often for RSUs, often for ESPPs. Restricted stock is more of a niche thing. Isn’t that crazy?
Andrew Chen 43:58
Yeah. Unless you’re keeping very good records and you’re anal retentive about tracking your strike price and your basis, etc.
First of all, if you are really anal retentive about doing that, you could probably do this on your own without making a mistake, but there’s lots of ways to screw it up, I think, is the point, right?
Shane Mason 44:20
Yeah, there’s lots of ways to screw it up. One tip is to watch for Code V on a W-2 because it will show you the amount of non-qualified income that’s in your W-2.
Unfortunately, there’s no indicator for RSU income that’s also in your W-2, so you’ve got to deal with pay slips. You’ve got to deal with historical transaction detail. That’s what our company does for our employees: just clean up this mess.
Andrew Chen 44:44
One thing I was curious about is, since you pay to exercise an option, and then you have this phantom income that’s imputed to you via the bargain element that you’re now responsible for paying taxes on, in the case of some clients that you’ve advised in the past, when there’s no secondary market for you to sell shares to cover some of the tax, if you don’t have the cash to pay the tax, what happens?
Shane Mason 45:13
You go to jail.
Andrew Chen 45:16
Is that the endgame pretty much? You’re stuck.
You’re going to have a liability to the IRS which you can’t pay, which is now accruing penalties and interests, etc. Is that the endgame?
Shane Mason 45:29
Yeah. That’s some of the exercises that we go through with our clients.
It’s like, “Here’s what we’ve got to deal with. How much cash do you have to handle this?”
Because in a perfect world, we would all exercise our options as soon as they’re granted, or as soon as they vest. And in a perfect world, they would all go up in value, and we have unlimited cash to deal with all the tax consequences.
Well, we don’t live in a perfect world. Typically, a client will come to us after their equity is worth a ton of money because that’s when you hire an advisor, and then we say, “Here is the cash that we have to deal with.”
What’s going to happen if I exercise this amount of options? Because I’m going to need to come up with cash for two purposes:
One, the actual amount to buy the shares. If they’re $50 a share, and I’ve got 100,000 shares, and I don’t have that amount of money, I need to pick which ones I’m going to exercise.
What’s going to happen tax-wise when I exercise those? What bracket am I going to be in?
What’s the actual cash outlay? When does that need to come out? We go through that exercise.
To answer your question, let’s say we’ve exercised too much, and now we knew that we have enough money to exercise them, but we didn’t have the money for the actual tax. Come April 15th of the year after you exercise them, you’re going to file your tax return and it’s going to say that you owe too much money, or more money than you expected.
What do you do? The main thing that I would recommend is going on an installment agreement. The IRS understands that this happens, and they have methods to deal with it.
If you owe less than $50,000, you can fill out an installment agreement request online automatically. It will automatically be accepted by the IRS if you owe less than that.
You can pay off your balance up to six years, so you can take your balance and divide it by 72 because that’s six years of 12 monthly payments. That’s how much you’ll pay.
And it’s actually quite manageable. It’s really hard to get so much income and have so little cash wherein you can’t pay it off over six years.
If that does become the case, then you can explore something called an “offer in compromise,” which is essentially where you offer to pay a lot less than your tax bill to the IRS. You essentially say, “I’ll never come up with that money.”
Andrew Chen 47:39
It’s like a workout.
Shane Mason 47:41
Yeah. Here’s where we’re going to negotiate all this.
I’ve been doing taxes for 10 years. I think I’ve submitted three or four, and on average, only 5% of them are accepted by the IRS because it’s quite a difficult process to sort out.
That’s a whole niche called tax resolution. But it can be done.
Andrew Chen 48:05
It sounds like finding yourself in this scenario should be pretty rare. But if you were that lucky person who joined Facebook in circa 2008, maybe this might have hit you.
Is that fair? It’s pretty rare, basically.
Shane Mason 48:21
Well, you might not have the cash now, but if you’re one of the lucky people that, let’s say you exercise all these shares, and the reason that you can’t pay your tax is because the value has gone incredibly up, you could just sell the shares, right?
Andrew Chen 48:33
Shane Mason 48:34
For short-term cap gains. That’s why we often recommend that.
What are you waiting for long-term cap gains? Are you really going to have to wait a year?
If you pay all the tax, and then you wait a year, and the value goes quite down, you’re just going to have what we call a capital loss whipsaw where you’ve paid ordinary tax rates on this huge value, then it goes down in value after you’ve paid ordinary tax rates. Now you’re going to have a capital loss in year two.
You can only take $3000 of a capital loss per year. Even if you have $1 million in capital losses, you can only take $3000. So it’s going to take you 170 years.
Andrew Chen 49:12
You’ll die first.
Shane Mason 49:13
Yeah, you’ll die first.
Andrew Chen 49:16
Unless you have a lot of gain sometime in the future to offset it with.
Shane Mason 49:20
Yeah, your cap gains can offset it in the future.
Andrew Chen 49:24
For ISOs, if you exercise, you get the bargain element, pay taxes on it, and then, when you sell, these things are risky, so the price could have dipped below your strike price. I think that’s the scenario you’re saying, right? Then you’re taking a capital loss?
Shane Mason 49:42
Yeah, it’s just a big loss.
Andrew Chen 49:46
I wanted to ask a little bit more about 83(b) elections because we touched upon it earlier, but we actually didn’t define it and discuss it too much. Can you talk a little bit about what it is, how it works, critical things to know about it?
Shane Mason 50:01
Section 83 of the Internal Revenue Code allows for the acceleration of income for restricted stock or restricted stock options into the current year.
“Why would you want to accelerate income from the future into the current year?” is the question. No one wants to do that.
Well, it could make sense if the income in the future is going to be gigantic, if the stock increases in value, but we’re trying to push income into the current year based on the current valuation of said stock.
Let’s say that you’ve got 1000 shares of a company that’s currently worth $1, so you’ve got $1000 of income. And a third of that is going to be vesting per year, so it’s $333 year one, two, and three.
So, you could take an 83(b) election and say, “I want to accelerate the $666 from years two and three into the current year. I’ll pay tax on that now because it’s not that much income.”
Because what could happen is it could go from $1 per share. We’re trying to increase the value of this company. That’s the whole goal of this enterprise.
It could go to $100 per share. Instead of $333 per year, we’ve got $33,000 per year.
If you don’t make the 83(b) election, you’ll pay $333 in year one, and then $33,000 in year two of income, and $33,000 in year three. It will probably even go up higher in year three if it’s increasing in value every year.
What we do is, to make an 83(b) election, within 30 days of receiving the grants, the company comes to you and says, “Hey, we’re going to give you these 1000 shares at $1 per share.”
It’s going to vest over the next three years. You have 30 days to make the election to accelerate that income into the current year.
Andrew Chen 51:53
That’s a hard requirement, too. That is not negotiable, right?
Shane Mason 51:56
Not negotiable, yeah. If you don’t make the deadline, then you’re out of luck.
You used to have to also attach the 83(b) election to your tax return. That’s no longer required. We still try to do it, just in case the IRS is a bit wonky.
You definitely do want to get certified mail receipt. I don’t think you can fax it in. You definitely can’t email it in, so it’s got to go in the mail.
You want to send it certified so that you know that the IRS has received it, and it’s postmarked, and all that. That’s the mechanics of it.
Andrew Chen 52:31
I was curious, in your example, vests over three years, because the thing that I think is a little hard to get your head around is if you do the 83(b) election, you’re saying, “I’m willing to pay tax on all of my grant now, even before I vest.”
You don’t even own the shares yet, so you’re paying tax on an asset that you don’t yet own but you’ve become eligible for. What happens if you leave the company, for example? Do you get a credit back or anything like that?
Shane Mason 53:02
No. That’s the crazy thing. I never really thought about that too much until it actually happened to one of my clients.
There is a risk that you’d take. The 83(b) election isn’t just the risk that the value…
Andrew Chen 53:19
The company goes belly up.
Shane Mason 53:20
Yeah, the company could go belly up and could be worthless. The other risk is that you get fired. I’ve seen it happen.
One of my clients, he exercised an 83(b) election. I think it was on $70,000 worth of stock. It was a lot.
He accelerated it into his tax year. Year two, he got fired for cause, and there’s no recuperating or recovering of any of that equity or that income that he paid in the past. That’s why it’s a risk.
Andrew Chen 53:50
If you’re separated for any reason, if you voluntarily leave because you found a better job elsewhere, you don’t get a credit there either, right?
Shane Mason 53:56
Right. It’s gone. That’s the risk you take when you accelerate it into the current year.
Andrew Chen 54:00
One thing I was also curious about for 83(b) elections is I noticed that not all companies offer the option to even do an 83(b) election, even though they might be offering stock options and many employees may want to do an 83(b) election for exactly the tax benefits that you outlined.
I’ve worked at companies that don’t have the option. I even asked them, “Do you have an 83(b) option?” and the answer was “No.”
Why don’t all companies offer this? Does it cost the company something?
Shane Mason 54:32
I don’t know. I honestly don’t know.
I’ve talked with so many founders and law firms, and I’ve seen so many stock option plans at so many companies. It is interesting where companies could have made a decision that was better for their employees, and you just don’t know why it didn’t happen.
It could just be that they don’t have good legal counsel. It could just be that they didn’t have the time, or it just didn’t make its way into the original stock plan, and it might be too late. Each stock plan is a bit different.
Some of them have requirements that certain things are available to clients. And some of them, they have to be able to exercise their options within three months of leading. Sometimes they can get more flexible and go six months.
But there’s a lot of reasons why companies are like, “No. Once that person is gone, we don’t want to deal with them anymore.”
I’m not sure exactly why they would not offer the 83(b) election. There could be some administrative issue surrounding it. They could just not want to deal with the blowback from an employee that doesn’t make the election.
They pay a bunch of tax a few years later, and then they’re mad at the company because the 83(b) election, they were tied to it, they were adjacent to it, but it was never made. They have to prove to the employee then at that point: “We offered it to you, but you didn’t take the election.”
It could be one of those types of things.
Andrew Chen 55:56
We’ve talked a lot about how the tax consequences work for different types of stock compensation, and 83(b) election, and different things to keep in mind with each type of stock-based compensation.
But the real question I would love to get your thoughts on: when you absorb all of this, what are some key tax planning strategies that stock option holders or RSU holders may want to know about?
Let’s say you’re an employee, or even an early employee, or a late employee, or maybe you’re even a founder, and you’re at the precipice of being granted or having stock-based compensation that is going to now be a material part of your income or your wealth.
Before you start making any moves, what are some strategies that would be good for such a person to know about from the very early stages, so that they can proceed thoughtfully and make good decisions?
Of course, obviously, one of those would be to consult a CPA advisor, for sure. But outside of that, what are things that folks should just keep in mind strategically?
Shane Mason 57:19
I know it’s annoying when a financial advisor says, “You should hire a financial advisor for all of this stuff.” But I am trying to get as much out of my mind to your listeners as possible to help them out.
With that in mind, one of the things that we talked about is that one of the big threats with all equity compensation is a higher valuation means more taxes generally.
So, if you have the ability to exercise stocks sooner than later, if you’re fortunate enough to have the money laying around to exercise stock, you want to exercise it as soon as possible, given the risk that the value doesn’t always go up for all of these companies, so you could be buying worthless stock.
One thing to keep in mind that we haven’t talked about yet, for anyone that’s early on at a company, an early employee, if you receive equity at a company before it’s worth $50 million, and the way that you would know that is you would ask the CFO of the company, “When did we tick over into a company worth more than $50 million?”
You could qualify for what’s called a qualified small business exclusion, which means that you got QSBS stock, which means that if you held it for long enough, you got it early enough, when you sell it, you can exclude up to $10 million of the gains from taxation.
A QSBS stock is worth a lot more than other types of stock because it’s not subject to taxes. It gets more complicated if you’ve got enough QSBS that it’s worth more than $10 million. We’ve got one client that’s worth $70 million of QSBS.
You’ve got to get fancy with estate planning attorneys. You can use various trusts to move that stock into the trusts for your kids, so that there would be multiple QSBS exclusions.
I hope some of your listeners are subject or have that type of situation. It’s obviously quite rare to have so much equity. But that’s one thing to keep in mind: QSBS.
That’s another reason to exercise a stock earlier than later because if you want until after that company no longer qualifies for QSBS, then you are locked out. There’s no phase out. When it clicks over, you’re done.
Ask the CFO or the finance team of the company when the QSBS is no longer available, so that you can get ahead of that.
What else should they do? The 83(b) election, in certain companies, is also available on incentive stock options, not just restricted stock. And how could that work for incentive stock options because they’ll vest in the future, the exercise issues or the income issues don’t even apply to ordinary income?
Well, the 83(b) election is available. You can actually accelerate the alternative minimum taxable income from the future into the current year for ISOs. That’s pretty rare, but it is available.
If you have ISOs, you might want to check out an 83(b) election at your company on the ISOs available. It could save you heaps in alternative minimum tax.
The interesting thing about restricted stock units is there’s not really much you can do about it. When they vest, they go into your income.
One tool that we can use mechanically to help avoid giant tax bills due, an interesting, kooky thing about them, is within our U.S. withholding system, most people think that when their RSUs and their non-qualified options vest, they’ve withheld 45%. “That surely must mean that I won’t owe any taxes on them.”
Well, the majority of that withholding is actually Social Security, Medicare, state and local income taxes, and then only 22% federal withholding. It’s called the supplemental wage rate, and it’s applicable to bonuses.
Anytime you receive a bonus in America, typically it’s withheld at 22%. But if you earn more than $100,000-$150,000, you’re in a higher bracket than the 22%. You’re probably in 32%-35%, or the top bracket of 37%, if you’re one of our fortunate listeners on the call.
If they’re only withholding at 22%, but you’re in the 37% bracket, you have 15% under withholding every time an RSU vests or non-qualified options exercise.
There’s no way to actually save taxes on that, but what I’m trying to tell your listeners is that you will probably owe taxes when you actually file your return. And you might have underpayment penalties as well.
One way you can get ahead of that is just try to do a tax projection, or if you know what bracket you’re going to be in every time you exercise options or you got an RSU vest, you literally mechanically and manually send a check to the IRS.
On their website, you can go in and make a payment of 15% times the bargain element or the value of the RSUs. I know that sounds like nothing that anyone wants to do, but it’s one thing that you can do to try to make sure that you actually have a refund at tax time rather than a balance due.
That’s three things. There’s a lot of other things that we can explore. Those are three of the main ones that come up.
Do you have any questions about those? Do you want to dig into that?
Andrew Chen 1:02:11
No, I think those all make sense. One thing I was curious about, though, is we were talking about earlier, there’s these gnarly two tax regimes: there’s regular and there’s AMT. Most people, most of the time, will be in the regular tax regime, but when they exercise options, they may actually flip over.
Is there any strategy where you would top up your AMT bracket with exercise? So you’re slowly exercising, so that it doesn’t exceed your regular tax liability. It just gets as close to it as possible so that you’re not paying…
Shane Mason 1:02:56
Andrew Chen 1:02:57
Yeah, so there’s basically a tax benefit. Or is that not a thing? I was wondering about that a moment ago.
Shane Mason 1:03:03
I hear you. I think you might have it a little bit backwards where, since you only pay the AMT when it exceeds your regular tax, maybe you’ll want to, if you’ve got the ability to increase your regular tax.
It doesn’t actually increase your overall because the AMT is essentially getting eroded by that regular tax. That is something that you could do.
Let’s say you’ve got incentive stock options, you exercise them, and they push you into AMT. You could also then exercise non-qualified options, because a lot of our clients have a mixture of equity. They have a mixture of all four a lot of the time.
So, you could exercise non-qualified options. They would just increase your regular tax, but your AMT would be essentially going down because you only paid the delta between the two.
That’s one thing you could do. That’s one strategy. I really like that if you’re also immediately selling those non-qualified options because you are not paying more tax to diversify out of your company, which is really what this is all about.
Honestly, what we try to do for all of our clients is just to get them out of a concentrated position in a tax-efficient way, and we don’t want the tax tail to wag the dog. It will often be less tax efficient to just get them out of that concentrated position.
Because that’s the real elephant in the room: you are financially independent, or you have a head start on most people, but not until you actually sell those shares. The company could go to zero.
If you’re at the casino and you’ve already won, we pay the tax to get out of the casino. It’s what we’re trying to do for our clients.
Andrew Chen 1:04:32
Yeah, makes sense. You were talking about the QSBS a moment ago, that if you were in the right circumstances, you’re an early employee at a company that ended up doing very well, but when you joined, it was just a handful of employees, under $50 million valuation.
But by the time you were ready to exit the company, your stock holding position, the equity compensation that you had earned was worth exactly $10 million. There is a scenario in which you might be able to walk away with that $10 million in equity compensation tax-free. There is a scenario where that could happen?
Shane Mason 1:05:15
Absolutely, yeah. Let’s say it’s worth $15 million and you sell it all on that year. You could only have a $5 million gain because of the $10 million QSBS exclusion.
Not every state respects QSBS. New York does. Other states do not always match the federal exclusion of income.
You’ve got to watch out for that. That goes with AMT as well.
California is, I think, the only state. There might be one other smaller state that also has its own AMT. But they also will enforce an alternative minimum tax at the state level.
Andrew Chen 1:05:52
Well, this has been really helpful. Pretty dense, but exactly the kind of stuff that folks need to know about, especially there are a lot of folks who work in the tech industry in the audience.
Where can people find out more about you, your work, your services?
Shane Mason 1:06:06
Just Brooklyn FI. That stands for financial independence. Brooklynfi.com.
We work with clients in all 50 states, more than a few clients outside the country. We have a team ready and willing to help you deal with your concentrated stock position.
You can also reach me at [email protected]
Andrew Chen 1:06:25
Awesome. We’ll definitely point to all that stuff in the show notes, and I look forward to sharing this with our listeners.
Shane Mason 1:06:32
You got it. Thanks, Andrew.
Andrew Chen 1:06:33
Cheers! Take care.