Tips for Minimizing Taxes on Stock Options and RSUs

Next week, I’ll be joining two fellow tax professionals alongside myStockOptions.com founder Bruce Brumberg to offer some crucial guidance on taxes and stock compensation. Here’s a link to our upcoming webinar on February 15, 2023, if you’re able to make it! In the meantime, I thought I’d share some relevant examples of how to minimize your taxes on your stock options or RSUs. We always recommend working with a CPA for your tax returns if you’re earning stock compensation…but sometimes CPAs miss things! We’re sharing the information in this blog post so you can be more of an active participant when working with professionals to minimize your taxes. We often see mistakes in 1099s and W2s - documents which we are told to rely upon. If you earned compensation in RSUs or you exercised stock options last year, pay attention to the details of this post so you can self-advocate when it matters.

Example 1: Jennie exercised ISOs and forgot to report them! TLDR: Jennie filed correctly, and was able to get a future tax credit! 

A few years back, Jennie was an early employee at a private tech start up and received incentive stock options as part of her compensation. She was very bullish (positive) on the company, and decided she wanted to exercise these options. What Jennie didn’t realize is that she should have reported these exercises on her tax return. 

If you exercise stock options, you should always let your CPA know. 

She exercised 10,000 shares, paid $1/share at a fair market value of $8 per share. This means the bargain element (or the value that she earned by exercising the stock) was $7 per share, or $70,000. Receiving a total value of $80,000 in stock by spending $10,000 in dollars is a fantastic trade. Although it may not be obvious, because no stock was sold, exercising stock is a taxable event. 

For non-qualified stock options, it’s harder to miss. The bargain element from exercising non-qualified stock options  shows up on your W2, something you’re always giving to your CPA. However, for incentive stock options, this is a separate tax form (Form 3921). You can access Form 3921 through your equity management software (e.g. Carta or Shareworks). Form 3921 will outline the following:

• Date of Option Grant

• Date of Exercise

• Exercise Price per Share

• Fair Market Value of Stock on the date of exercise

• Number of shares exercised

With this information, your CPA will be able to record the exercise. The good news with incentive stock options is they have a tax incentive. This means, it may or may not have an immediate tax impact. The bargain element of incentive stock options is reported on your Alternative Minimum Tax (“AMT”) Form 6251. You’ll only be assessed a tax if your AMT is higher than your ordinary tax. If it’s not, you won’t owe a thing! In either case, your AMT cost basis for your stock will now be recorded, so when you eventually sell your stock for a bigger gain, you’re more likely to get a tax credit. 

Fortunately for Jennie, she was able to revise her historical tax returns to incorporate this stock option exercise. This also allowed her to take advantage of the tax credits upon selling her stock. 

Example 2: Robert received a W2 from an employer he stopped working for several years prior. TLDR: adjustments were made on Robert’s 1099 to correct the cost basis of sold stock, and remove any tax implications from this confusing W2! 

Robert spent a few years working at a tech company where he earned non-qualified stock options. He quit in 2018, and in February 2021 he received a W2 from his old company. How strange. We dug into the details, and noticed the amount on the W2 was similar to the proceeds of stock sales he made in 2020. 

The W2 was actually correct. Robert had exercised and sold non-qualified stock options. Even though he no longer worked for this tech company, because his non-qualified stock options were tied to his compensation during his employment, his company responsibly filed the W2 on his behalf. The problem was that his 1099 was double counting this income. 

How could we tell?

• Line 1 on the W2 = $50,000

• 1099-B showed:

• $70,000 sale (fair market value of sale)

• $20,000 cost basis (price to exercise options)

If Robert’s CPA filed in accordance with the W2 and 1099, he would have paid taxes on:

• Ordinary income of $50,000 related to employment income

• Short-term capital gains of $50,000 related to the sale of stock options that were exercised and sold. 

We recommended that Robert work with his CPA to adjust the cost basis of the stock options that were exercised and sold. Good news is, many 1099s provide a ‘1099 supplement’ that show the adjusted cost basis. Robert was able to provide this to his CPA, and only paid tax on $50,000 versus $100,000. This saved him almost $25,000. Time well spent. 

Example 3: The 2022 market decline pushed Kendall’s company into QSBS territory, i.e. assets below $50 million. TLDR: Kendall exercised shares, locking in the most efficient capital gains treatment. Only time will tell for Kendall, but this rule can save individuals millions of dollars in taxes.  

Kendall is a consultant for a variety of venture capital businesses. Each year, we review Kendall’s stock options to determine if Kendall should exercise her options. 

The pertinent data:

• Grant date, vesting schedule, strike price, expiration date

• Current FMV (this must be reported by the company, or requested from the company if not reported)

Over the past few years, we’ve elected not to exercise for the following reasons:

• The options are NSOs with strike prices near their current fair market value. 

• Kendall is in the 24% tax bracket, so the incremental difference between capital gains tax and ordinary income tax is not too significant. 

• In addition to consulting to start-ups and earning NQSOs, Kendall is an independent investor in companies. She decided she would rather continue investing, and maintain her optionality in the companies she consults for. 

But this year, the market shifted. 

• The aggregate value of private equity exits globally came in at $391.44 billion for the year, down 32.1% from the 2021 total, according to private markets data source Preqin Pro.

• Carta saw similar figures. Of the 91 transactions of companies on their platform, deal count was down nearly 30% year over year, while annual transaction value fell 58% from 2021. 

• Private markets are more opaque in pricing due to lower liquidity, but discounts can show similarities to the public markets. In 2022, small cap US stocks were down 20%, and US growth stocks down 29%. 

With a market in decline, we saw reported fair-market-values drop in some companies below a very important threshold: $50 million.

QSBS Qualification Requirements: 

• 409A valuation of $50 million or less. 

• The equity must be a stock. Stock options, warrants, and convertible assets do not qualify.

• Must be held for at least five years.

QSBS Tax Treatment

The federal capital gains exclusion is limited to $10 million or ten times the adjusted cost basis—whichever is greater. Past that amount, any excess gains on the sale will be taxed at regular capital gains rates. Let me repeat, you can exclude up to $10 million of capital gains in calculating your tax!! Let’s say your stock grew from $10 to $10,000,010…you wouldn’t pay a thing! Check out myStockOptions article: Techniques To Defer Or Eliminate Taxes On The Sale Of Your Company's Shares for further details on QSBS. 

Carta kindly notified us of the changes to the companies Kendall had stock options, but we recommend assessing if your company falls within this threshold. For Kendall, we recommended she exercise non-qualified options:

• Kendall remains bullish on the company, despite the recent decline.

• The FMV of the company is above the exercise price. 

• This allows Kendall to start the clock on obtaining QSBS status. Stock counts towards the 5 years, stock options do not. 

We don’t know where Kendall’s stock will be over the next 5-10 years, but we do know that she can afford this investment, can handle the illiquidity, and if it goes up, taxes have been optimized! 

Rounding it out

Aren’t stock options and RSUs fun?! We very much wish we could blindly rely on tax documents, but unfortunately even the documents you’re meant to rely upon frequently deserve a second look when you’re dealing with stock compensation. We always recommend hiring a qualified CPA when filing taxes for stock compensation, and working with your fee-only financial advisor (CFP® or CFA®) to make these decisions in alignment with your overall financial wellbeing and goals.

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Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.