Decision-making moments come at you fast when you have stock options, restricted stock units, an employee stock purchase plan, or other forms of company equity compensation. It’s best to have financial and tax plans in place ahead of time.
The early part of the year, before you focus on your tax return, is an opportune time to consider your planning for the year ahead. Now that the Tax Cuts and Jobs Act is likely to be extended beyond 2025, you have much less uncertainty in tax planning than before the 2024 election.
Financial and tax advisors routinely use the year-start period to get their clients to consider what’s next for their stock comp and holdings of company shares. This article presents what some leading advisors tell their clients.
Thinking Ahead: Questions To Ask
John Barringer, the managing partner of Executive Wealth Planning in Denver, explains that in his approach to clients, the early-year window is “a mirror of the end of the year—same basic questions as we had then.” One of those questions Barringer asks his clients at year-start concerns the prospects for new equity awards. “What grants do you expect?”
Barringer furthermore emphasizes the importance of knowing — and giving your financial advisor — a complete picture of your equity comp and company shares. “I’m surprised how many times clients will go into the brokerage website and click and sell something without telling us what they’re doing.”
Barringer adds that you also want to be aware of stock option grants that are scheduled to expire this year, along with what would happen to stock options and RSUs should you lose your job. If you think you may take a new job at a different company, answers to key questions will help you negotiate severance or a new compensation package.
“What option grants will expire soon or could expire if you’re laid off?” Barringer asks his clients. “What grants do you expect to receive in the first quarter or first half of the year? What RSUs vest in the coming year?”
Job Changes Ahead?
Clients’ job situations and career goals are a routine year-start focus for Rebecca Conner, the founder of SeedSafe Financial LLC, based in Austin, Texas. Any moves in the year ahead could affect income and the need to exercise options sooner than anticipated, depending on the company’s post-termination exercise deadline. “Review job expectations. If you’re making a move this year, consider your total expected income and the impact of any stock options that you may need to exercise when you leave your current job for a new one.”
Tax Planning For Withholding
“Prepare for estimated taxes for RSU under-withholding,” advises John Owens, Managing Partner at Brooklyn FI in New York. One of the tasks he likes to do with clients as part of year-start planning is to get ahead of the game and map out the estimated payment for at least the first quarter.
Why? The federal flat withholding rate at restricted stock/RSU vesting for most employees may not cover all of the taxes you owe to the IRS, depending on your tax bracket. The flat withholding rate that most companies use for employees’ supplemental wage income is 22% (it is 37% for yearly total amounts in excess of $1 million). One way to remedy a meaningful tax shortfall is to pay quarterly estimated taxes.
ESPPs
Owens also points out that year-start is a great time to enroll in, or review your salary contributions to, an company employee stock purchase plan. He is an ESPP fan, especially if the plan has “a good lookback provision for calculating the purchase price.” An ESPP with a discounted purchase price and a lookback can be a good deal, even if the stock price declines after enrollment.
Tax Returns
Tax season is another year-start client focus for Conner. “Early in the year, we’ll be getting ready for tax returns, so we’re looking for forms. We’re making sure we know where things are or when things are due. We’re re-checking cash to be sure we have enough for taxes as well as all of our strategies.”
Special Issues For Incentive Stock Options
Special issues arise with incentive stock options and the alternative minimum tax. You can trigger the AMT when you exercise ISOs and then hold the shares beyond the calendar year of exercise, though this is less likely under the TCJA than it used to be. Many experts say that the first quarter of the year is the best time to exercise ISOs, given the ISO tax treatment.
Here’s why. With ISOs, when you sell the shares after holding them for more than one year from exercise and two years from grant, your entire gain over the exercise price is capital gain (no ordinary income). This a called a qualifying disposition.
However, when you hold the shares beyond the calendar year of exercise, the spread at exercise becomes part of your AMT income calculation, not your regular income tax, for that year. As you pay the higher of either your AMT or your regular income tax, an ISO exercise followed by holding the shares through the calendar year of exercise can result in paying the AMT on paper gains recognized at exercise — even if the stock price has since fallen.
Therefore, one core strategy for ISOs is to exercise the options early in the year and then re-evaluate the stock price in late December. If the stock price has fallen since exercise, you can sell before year-end and eliminate the AMT on your paper profits from the exercise spread. This is sometimes called an “escape hatch” strategy.
That is why Owens emphasizes with his clients the importance of year-start planning for ISOs. “I love an early-year ISO exercise,” he enthuses. “Early in the year, we’re talking with clients about whether to do ISO exercises and holds.”
Exercising ISOs early in the year gives you the rest of the year to see where the stock price goes, he explains. This allows plenty of time to make decisions about whether to sell the shares or whether to hold them beyond year-end. If you owe the AMT because of the ISO shares that you hold, you can sell some of the ISO shares the following year at your long-term capital gains tax rate to pay the AMT. For startup companies, with 409A stock-price valuations staying flat or declining, John also suggests this as an early-year strategy to consider, though it brings additional risks and a lack of liquidity in the shares that you acquire.
Conner also advises ISO exercises early in the year. She particularly favors doing so when the stock price is depressed and/or when the company’s outlook is positive. “Then if something happens during the year you can always sell the stock if you need to and disqualify it.”
Year-End Strategies
For planning actions to take at the end of the year, see another of my Forbes.com articles: Post-Election Financial Planning For Stock Options, RSUs, And ESPPs. Many of the advisor recommendations presented in it remain relevant every year.
Read the full article here
