To put it bluntly, this year has been an emotional roller coaster. In a few short months we went from watching a mysterious virus from afar to navigating a pandemic and the sharpest stock market drop in recorded history.
So we can appreciate how the thought of a lingering tax liability might make you feel financially vulnerable. That's why it’s so important to understand how and when your equity grants are taxed.
Your tax liability varies by equity type
Unfortunately, for some of us that’s often easier said than done. Equity grants are byzantine by design. Each type has unique tax considerations that can make planning a challenge even for financial services professionals.
The most common type of equity among technology professionals is restricted stock units (RSUs). Relatively speaking, they’re the most straightforward. But don’t be fooled, they can still be complex to plan for.
In our experience, one of the things that catches technology professionals off guard is cash flow. Meaning even if the tax calculation is simple, planning for how the expense gets paid may not be.
Let’s assume you had 500 shares of Amazon vest last year and you didn’t sell any. Since RSUs are taxed at vest, you would have a lot of income recognized last year. And that income would potentially create a tax liability that needs to be paid next month.
What this means is that your tax activity and cash flow impact do not always align. This isn’t necessarily a bad thing but if we add employment uncertainty or cash flow constraints (like needing to pull six figures out of a hat in an economic downturn) you can see how this may matter more than you realized.
Tax liability and out of pocket expense are not always the same
One of the biggest factors in determining your out of pocket expense is something called ‘withholding’. If that’s not a term you’re familiar with we won’t hold it against you. There’s no technology professional handbook that explains these things. And if we’re being honest, it would make for a total snooze anyway.
Withholding is the amount of money your employer takes and sends to the government on your behalf. But unbeknownst to many, it’s not done for all equity types. That’s an important detail you don’t want to overlook.
Another potential surprise for high-earning technology professionals comes when they discover the amount being withheld is not enough. Fortunately, some companies allow you to increase your withholding.
Let’s look at those 500 shares of Amazon that vested last year again. As you can see, RSUs are subject to withholding but in this case only 20% is being sent to the government.
It’s probably safe to assume that this Amazonian is taxed at the highest level. So there could be a significant out of pocket expense next month if estimated voucher payments aren’t already being made.
Withholding comes in many different flavors
Another variable to consider is what withholding method is used. It can vary by company to company and potentially equity plan to equity plan. And it matters because each type impacts your take home pay slightly differently.
Fortunately, we’ve found that most technology companies prefer share withholding. Our clients like this method because it doesn’t lower your take home pay. However, it does reduce the number of vested shares available for sale.
That final point is a consistent source of confusion. So if you’ve ever wondered why the number of vested shares for a given period doesn’t match the number of shares deposited, this could be why.
It all comes back to planning
The last consideration in our Amazon RSU example is the taxation of gains. Even though the stock was taxed at vest, capital gains will apply on any future sale. So if this Amazonian sold stock this year, potentially to fund the large tax liability next month, it would extend the cash flow planning beyond the 2020 calendar year.
Another year? Sigh.
The biggest takeaway from this example is the importance of tax planning for equity grants. No one likes surprises, especially when they have lots of zeros after the dollar sign. Which is why there’s so much value in getting the help of a trusted guide.
At Schmidt Financial Group, we pride ourselves on the work we do to integrate taxation into a broader financial plan. We work closely with aligned tax professionals to ensure your investments, diversification plan and taxation all work together. We strongly believe the end result is a superior plan that eliminates surprises. And who wouldn’t want that?
Please review our disclosures and discuss your situation with a financial professional before making any investment decisions.
