How to Keep Your Taxes Under Control in an IPO Year



The time leading up to your company’s IPO or SPAC merger can be intensely exciting and, at times, overwhelming. A debut on the public market often marks a steep increase in income for employees. This new influx of wealth, however, requires a new level of tax planning. Here are the steps you need to take to keep your tax obligation under control in your company’s IPO year.

Understand what you own.

Companies may offer their employees many different kinds of equity compensation, which are subject to different tax rules. Before you can begin to manage the tax consequences of your company stock, you must understand what type (or types) you own.


Incentive Stock Options

Incentive stock options (ISOs) represent the right of an employee to buy a specified number of company shares at a price equivalent to the shares’ fair market value at the time the options are granted (referred to as the “strike price”). As the shares’ market value increases, so does the discount an employee receives when they exercise their options. When Qualified ISOs (discussed later) are sold, the difference between the strike price and sale price is taxed as capital gain (or loss).


ISOs and the AMT

You can experience tax consequences from ISO shares well before you sell them, however. The alternative minimum tax (AMT) is an alternate tax calculation that excludes certain tax benefits to ensure that high-income taxpayers pay at least a minimum amount of tax. When your incentive stock options vest, you must report the bargain element (the difference between the strike price and the current fair market value) under the AMT calculation.


The 83(b) Election

When a company is successful, its share price typically increases over time. This is what most people expect when they receive stock options, and it’s why early investors in successful companies can often realize tremendous gains. The downside of rising share prices, however, is the corresponding tax liability. The larger the difference between the strike price and current fair market value at the time ISOs vest, the larger gain must be reported for AMT purposes.


Section 83(b) of the Internal Revenue Code offers a way to potentially minimize the bargain element that must be reported for AMT calculation. Some companies allow employees to exercise their stock options before they vest; this is commonly referred to as “early exercise.” If you exercise stock options early and file an 83(b) election within 30 days of the date your options were granted, the bargain element is realized for AMT purposes at the time of granting rather than on the vesting date.


If your company’s share price increases, then claiming the bargain element early will result in a lower number for your AMT calculation. It’s important to realize, however, that share price increases are never guaranteed and all investments carry a certain amount of risk. If you exercise your options early and file an 83(b) election and the price of your shares subsequently falls, then the reportable bargain element could be higher than it would have been without the 83(b) election.


Non-Qualified Stock Options

Non-qualified stock options (NSOs) can be offered to a larger pool of individuals than ISOs, but they don’t have the same tax benefits. Like Qualified ISOs, gains or losses realized when shares are sold are treated as capital gains or losses. At the time of purchase, however, the bargain element of NSOs is reportable as wages rather than merely for AMT calculation. The 83(b) election can also benefit employees who exercise NSOs early, allowing them to calculate the gain on the day the options were granted rather than on the vesting date.


Restricted Stock Awards

A restricted stock award (RSA) is a grant of company stock that typically vests over a period of years. Employees usually pay a minimal purchase price for RSA shares. The bargain element of an RSA is taxed as ordinary income at the time of vesting. Like stock options, owners of RSAs can choose to file an 83(b) election within 30 days of granting and calculate the bargain element at the time of granting instead of waiting for their shares to vest.


While owners of ISOs, NSOs, and RSAs can potentially limit their taxable income with an 83(b) filing, it’s important to fully understand the risks as well as the potential benefits of doing so before making a decision. Consult with a fiduciary investment advisor who has experience with the IPO process as well as tax expertise to make the most informed decision.


Restricted Stock Units

Restricted stock units (RSUs) are company commitments to deliver shares to employees after they meet specified vesting conditions, such as a certain amount of time in service to the company. When only one vesting condition is attached to an RSU, it’s called a “single-trigger” RSU. Sometimes, however, RSUs vest only after the company goes public. These are called “double-trigger” RSUs, since two conditions must be met. This can result in all shares vesting at once—and, consequently, a steep increase in income in a single tax year.


RSUs are typically transferred over time. They are taxable as wages, and employers withhold taxes as they transfer shares to employees. Often, however, withholding is insufficient to cover the associated tax liability, so employees must increase withholding rates and/or send additional quarterly payments to the IRS. Unlike stock options and RSAs, RSUs are not eligible for 83(b) election. At sale, gain or loss on RSUs is reportable as capital gain or loss.


Be mindful of holding periods.

After your company has its IPO or SPAC, you will likely be subject to an initial lockup period that prevents you from selling your pre-IPO shares. This ordinarily lasts six months, but it could be shorter or longer, depending on the underwriting agreement and the process through which your company is going public. Depending on when you exercised, waiting longer to sell, however, may have a favorable impact on your taxes.


Short-Term vs. Long-Term Capital Gains

Capital gains are subject to two different tax rates. Short-term capital gains are taxed like ordinary income, while long-term capital gains enjoy a significantly lower rate, topping out at 20% for tax year 2021. To qualify for long-term capital gains rates, you must hold an investment for at least one year. Additionally, ISOs must be held for at least two years after their grant date; otherwise, the sale is considered a “disqualifying disposition,” which makes the bargain element taxable as ordinary income rather than receiving the beneficial treatment of an ISO.


Qualified Small Business Stock

If your company is a domestic C corporation that has less than $50 million in assets at the time your stock is issued, your shares may be considered qualified small business stock (QSBS). If you hold QSBS for at least five years, and the company uses at least 80% of its assets for business operations during that time, then gains up to $10 million on the sale of these shares may be exempt from federal taxes. If you think your shares may be QSBS, talk to a tax and investment professional to understand how to get the best possible tax treatment for your gains.


Get trusted tax and investment advice.

An experienced fiduciary investment advisor can help you develop a sales strategy designed to maximize your after-tax gains. One way an advisor can help you do this is with active tax-loss harvesting. This strategy involves selling losing stocks to offset gains on an ongoing basis, replacing these losing stocks with similar ones to maintain portfolio balance.


If your company is gearing up to go public, the time to get professional tax and investment advice is now. Your company’s IPO could be your greatest chance to reap a huge financial windfall; don’t let a poor tax strategy undermine it. To learn more about how to get the most out of the IPO process, visit our resource center.