The Three Keys to Saving on Taxes with Company-Based Stock
Many corporate and tech employees accumulate a great deal of employer stock via Restricted Stock Units (RSU), Incentive Stock Options (ISO), Non-Qualified Stock Options (NSO) and Employer Stock Purchase Plans (ESPP). Unfortunately, receiving stock-based compensation creates a great deal of tax complexity for the recipient that can be difficult to sort through.
In this episode of Coffee, Sweaters, and Finance!, Morgan Ranstrom, CFA, CFP®, a financial planner at Trailhead Planners and Bill Mulvahill, CFP®, CPA, a financial planner at Essential Wealth, discuss three keys owners of company stock can use to lower their tax bill and make better decisions with their company stock.
Morgan: 00:03 (silence).
Morgan: 00:13 Welcome to the third episode of Coffee-
Bill: 00:15 Sweaters, Finance.
Morgan: 00:17 ... and Finance!
Bill: 00:19 Well, we're still working on the timing there.
Morgan: 00:20 Yeah.
Bill: 00:21 We'll get it.
Morgan: 00:21 Yep. I've been saying and finance.
Bill: 00:23 I just shout finance.
Morgan: 00:25 Yeah.
Bill: 00:28 All right.
Morgan: 00:29 Do you have a question for me?
Bill: 00:30 No. You got the question for me, I believe.
Morgan: 00:31 No. Remember the question though?
Bill: 00:33 Oh, did you start the fire?
Morgan: 00:36 We didn't start the fire.
Bill: 00:37 Oh, I'll get it right next time. I asked the wrong question.
Morgan: 00:42 We didn't start the fire.
Bill: 00:43 Okay. All right.
Morgan: 00:46 Anyways, here we're going to talk about the three keys to saving on taxes with your employer stock.
Bill: 00:54 Oh, okay.
Morgan: 00:55 The three keys.
Bill: 00:56 The three keys.
Morgan: 00:57 What would be number one in your mind, Bill?
Bill: 00:59 And so it has to be limited to three, so, right? Is that the game here?
Morgan: 01:05 Yeah, I think so.
Bill: 01:05 Three top.
Morgan: 01:06 Top three.
Bill: 01:06 We'll see, maybe there'll be a bonus one at the end.
Morgan: 01:08 Maybe.
Bill: 01:09 Okay. All right. The first thing I think everyone should do anytime they have employer stock, it just kind of basics, is make sure when you exercise stock options or you have restricted stock vesting, that you set aside enough for estimated payments for the taxable income hit.
Morgan: 01:39 Yeah, yeah.
Bill: 01:39 They'll withhold, but it's usually not enough. So you want to make sure that you set aside enough for that so that when April 15th comes around, you're not slammed with a tax bill, that you don't have the cash to pay.
Morgan: 01:48 April is coming.
Bill: 01:49 Yep. April is coming.
Morgan: 01:51 April it was coming.
Bill: 01:51 Yeah.
Morgan: 01:52 And that's a big one, is people don't often think or often don't think about the tax effects and then they get a surprise in April. Never fun. Especially when it can be tens of thousands or even more.
Bill: 02:02 Yep. Absolutely.
Morgan: 02:04 Yeah.
Bill: 02:04 So that's one that's, that's just basics. That's not going to save you taxes, but it's more about preparing to make sure that you're not getting ahead of yourself.
Morgan: 02:13 Yeah. I'm going to throw a number two if that's all right.
Bill: 02:15 Go for it.
Morgan: 02:16 Don't get caught without a plan.
Bill: 02:17 Don't get caught without a plan.
Morgan: 02:18 So I think, and you'll hear us talk about this a lot, is have a plan, have a strategic plan, financial plan for when are you going to exercise, what's coming down the road if there's more stock coming your way.
Bill: 02:31 To that point. So with restricted stock, when you get restricted stock and you have the vesting schedule, you have a clear picture into how that is going to hit your tax return over the next few years.
Morgan: 02:44 Sure.
Bill: 02:44 So let's just say you have X thousand dollars worth of restricted shares and invest over three years. You know what's going to hit your tax return in the next three years. Now the stock price could change, but you have, you at least know the number of shares that you are going to invest. So you have a window in the scene how that's going to impact your tax return. So if you have a plan, you can do any steps, prepare for any steps needed today to... Let's just say-
Morgan: 03:12 That's a case where we can plan that to the day.
Bill: 03:15 Yep. And let's just say, here's a classic case. As they invest, it pushes you into a higher marginal tax bracket. If you have charitable goals, that would probably be a year to gift to cherish.
Morgan: 03:29 Sure.
Bill: 03:30 Time it to align with the year that you have a big tax [crosstalk 00:03:34]
Morgan: 03:34 And hey, if you've got some low cost basis stock that you got from your company, that might be a good time to use that stock. Donate that stock. Get two birds with one stone there.
Bill: 03:44 Yep.
Morgan: 03:44 Yep.
Bill: 03:46 So that's the second one.
Morgan: 03:48 Yeah. Don't get caught without plans. So we've got, April is coming. Number two, don't get caught without a plan. What's the number three that you would say?
Bill: 03:54 A third one. Let's see. I think so. I think one and two are pretty strong.
Morgan: 03:59 Should we stop the two keys to savings taxes on your...
Bill: 04:02 Yeah.
Morgan: 04:03 No, let's-
Bill: 04:04 I'm going to throw out a third.
Morgan: 04:05 Okay.
Bill: 04:06 It's a little more of a side note. I'd say less core than the first two, but with-
Morgan: 04:12 Three asterisks.
Bill: 04:13 ... employer stock purchase plans.
Morgan: 04:15 Okay. Yeah.
Bill: 04:17 Usually you get an employer match or discount with that. And then when you sell it, you're going to pay, oftentimes you're going to pay a taxable, a gain, assuming the stock price goes up over that window.
Morgan: 04:29 Not guaranteed.
Bill: 04:30 Not guaranteed.
Morgan: 04:31 Yeah.
Bill: 04:31 Yep. But a lot of times people just participate and then they sell it whenever they need the money. But if you sell it and you hold until the qualifying disposition date, which is usually between one to two years after you get it. If you hold until then, then that discount component is going to be taxed on longterm capital gain rate rather than ordinary income rate.
Morgan: 04:55 Sure, sure.
Bill: 04:56 So this all plays into having a plan for how you're going to diversify, when are you going to sell the restricted stock? When are you going to exercise the options? When are you going to sell ESPP? You want to have a plan, make sure that's all coordinated. But with employers stock purchase plans in general, a lot of times I see people that are managing it on their own that don't sell. They don't hold it until the qualifying disposition date. Then they end up paying more in taxes than they would have needed to if they just held it long enough.
Morgan: 05:28 Sure, sure, sure. That makes sense. So, have a plan specific to each type of employer stock that you might receive or purchase.
Bill: 05:35 Yep.
Morgan: 05:36 Yeah. So, once again, three keys. Don't get caught without a plan. April is coming and then, specify your plan, I would say, for the type of employer comp that you're getting.
Bill: 05:49 Absolutely.
Morgan: 05:49 Yeah. All right. Thanks guys. That's it for today. That, that, that... That's it for today.
Bill: 05:55 Great.