Company equity can be lucrative and potentially life changing but it can also be challenging to understand and intimidating to navigate. In part two of this guide we will continue sharing the strategies for equity compensation and the power of partnering with financial advisors and CPAs following the path of a hypothetical executive, Sarah.
6. Balancing Long-term Capital Gains and Ordinary Income
Balancing the tax implications of long-term capital gains and ordinary income is a key consideration when managing your equity compensation. If Sarah holds her shares for at least a year after exercise and two years from grant (for NSOs/ISOs) or after vesting (for RSUs), any gain from the sale qualifies for long-term capital gains tax rates, which are typically lower than ordinary income tax rates. However, this requires her to assume the risk of holding the stock.
In contrast, she might choose to sell earlier under certain conditions, recognizing the income as ordinary income for tax purposes. This decision is about balancing potential tax benefits against market risk and Sarah’s personal financial goals.
In these nuanced decisions, collaborating with a tax professional and financial advisor provides Sarah with a balanced approach. Together, they strategize on the optimal timing of stock sales, considering both potential tax benefits and market conditions, which aids in reducing her overall tax liability while aligning with her risk tolerance and financial goals.
7. 83(b) Election for Early Exercise Options
If your company permits early exercise, the 83(b) election allows you to declare the value of the "bargain element" of your stock options up front. Despite the risk of the company's value not appreciating as expected, Sarah finds this provision worthwhile. Given her confidence in her company's robust growth trajectory, she opts for an 83(b) election, potentially reducing her future tax liability. Making informed decisions about this tax provision could significantly impact your tax liabilities, and hence, your net income.
8. Tax-efficient Charitable Contributions
Donating long term held appreciated stock is a powerful way to contribute to causes you care about while also gaining a tax benefit. If Sarah donates an appreciated security that she's held for more than a year, she can claim a charitable deduction for the market value of the security (up to a certain limitation by the IRS) and avoid paying capital gains tax on the appreciation.
Sarah also explores the benefits of a Donor Advised Fund (DAF) with her financial advisor. By contributing her long term held appreciated stock into a DAF, she’s eligible for an immediate tax deduction and can recommend grants from the fund over time. This approach allows Sarah to support the charities she loves while receiving an immediate tax benefit and avoiding capital gains tax.
Charitable contributions offer both personal satisfaction and potential tax benefits, a win-win scenario. Involving a financial advisor in these decisions ensures you're making the most tax-efficient contributions possible, maximizing both your philanthropic impact and financial benefit.
9. Estate and Gift Tax Considerations
If your equity compensation pushes your estate value above the federal estate tax exemption amount, you may want to consider strategies to reduce potential estate tax liability. For instance, Sarah gifts shares during her lifetime, which reduces the size of her estate and may also provide a way to share wealth with family members in lower tax brackets. She does this while being mindful of company blackouts and open window periods.
Sarah doesn't navigate these complex considerations alone; she engages a financial advisor and tax professional. These professionals help her understand the nuances of estate and gift tax laws, and strategically plan to minimize her estate's potential tax liability. For example, they guide her on the advantages of lifetime gifting or establishing trusts, keeping in mind the ever-changing tax laws.
With their expertise and guidance, Sarah sees estate and gift tax considerations not as a source of stress, but as an opportunity for thoughtful wealth transfer planning. The result is a well-planned strategy that preserves her legacy while reducing tax exposure.
10. Understanding Equity Compensation to Better Manage Personal Financial Goals and Cash Flows
Concluding our series of considerations, we focus on an aspect that underlines them all – understanding your equity compensation in the pursuit of managing your personal financial goals and cash flows. Equity compensation, often a significant component of your income and net worth, necessitates informed planning.
To help Sarah orchestrate this complex process, she collaborates with her financial advisor and tax professional. Their expert guidance navigates her through intricate tax laws, risk management, and the potential maximization of her equity compensation. Hence, her equity compensation transforms from an employer's benefit to a potent tool for wealth creation.
Embracing a holistic perspective, Sarah synchronizes her stock sale events with sizable upcoming expenses, securing liquidity when needed. She also strategically times the exercise of her options to optimize tax liabilities, while keeping his financial ambitions on track. It’s not merely about grasping the details of equity compensation but leveraging it as a powerful tool in your financial plan.
Having a deep understanding of your equity compensation can potentially provide better outcomes for your personal financial goals. Mastering the nuances of equity compensation can be a challenging endeavor, but the rewards are great.
Here at Brickley Wealth Management, we've been assisting many high-value executives, employees, and their families for decades. Our combined financial advisory and tax firm specializes in optimizing executive compensation and company stock. The considerations outlined in this guide, as seen through Sarah's journey, form the bedrock of the strategic discussions and planning we engage in with our clients. Start planning your financial future today with our team.
We believe that to properly manage your assets, we need to have a complete picture of who you are and what you hope to achieve.