The myStockOptions Blog

Two Special Tax-Return-Reporting Issues In 2023: Volatile Stock Prices And Employee Mobility

Over a decade passed between the Great Recession of 2008–2009 and the volatile market downturn of 2022. As a result, many younger employees with equity compensation—whether stock options, restricted stock units, employee stock purchase plans, and/or and company shares—are new to the impacts of fallen stock prices and capital losses in their tax-return reporting. For some, the 2023 filing season will be the first time they hear the terms "tax-loss harvesting" and "wash sales."

Another widespread issue for tax reporting that is new to many employees involves interstate employee mobility and the allocation of income between states. That is, of course, on the rise as more employees than ever work remotely in a different state from their employer, whether in one place or as “digital nomads” moving from state to state.

In a recent myStockOptions webinar on tax returns that I moderated (Preventing Tax-Return Mistakes With Stock Comp & Stock Sales), three leading financial and tax advisors with expertise in equity comp presented ideas and tips for preventing costly tax-return errors in 2023. This article summarizes some of the key points they made about capital losses, wash sales, and employee-mobility issues.

Down And Volatile Stock Prices? Consider Tax-Loss Harvesting...

Amid the down and volatile stock markets of 2022, many employees with stock comp have capital losses from selling company stock whose value fell after vesting, exercise, or purchase. On your tax return, you can apply your capital losses to offset your capital gains, thus reducing your taxable capital gains income. After that, you can also net up to $3,000 (for joint filers) of capital losses against ordinary income (e.g. your salary, income from RSU vesting, income from NQSO exercise). Any usused capital losses are carried forward. This is called tax-loss harvesting.

Webinar panelist Stephanie Bucko, a CPA and the co-founder of Mana Financial Life Design in Los Angeles, routinely uses this strategy to help reduce her clients’ taxable income on tax returns. “It definitely impacts the strategy. You can cut out a ton of taxes if you’re able to offset gains with losses.” She uses software to capture her clients’ full financial picture and also talks through their history to identify any capital losses that may be available to net against gains.

“It is likely for tax year 2022 that clients will have capital losses on their tax return,” Stephanie concluded. She pointed out that selling loss-makers can be useful not only to harvest the loss but also to diversify out of a concentrated stock position. “This presents an opportunity for clients with concentrated positions to reduce risk without suffering tax consequences. Our recommendation is to review Schedule D for these tax losses.”

Tax-loss harvesting is also pursued by webinar panelist Daniel Zajac, a CFP, Enrolled Agent, and managing partner of Zajac Group (Exton, PA). He noted that the volatile and declining stock prices of 2022 presented opportunities to take advantage of capital losses not only to offset any capital gains in 2022 but also to carry remaining losses forward to future tax years.

“In a year like last year,” Daniel went on, “I think that a lot of advisors were talking to clients about capturing some losses and carrying them forward. For many advisors that’s part of the process at year-end, and it’s funneled through to the tax preparer to be sure it gets accounted for.”

...But Watch Out For Wash Sales

Be aware that there are limits on tax-loss harvesting for those who try to be too clever with it. If you sold loss-generating stock before the end of 2022 for tax-loss harvesting and then repurchased the same stock in January to keep your investment in it, you will run into the “wash sale” rule. This is triggered by a sale of stock at a loss coupled with the repurchase of the same stock within 30 calendar days before or after the sale.

The result? Your capital loss is disallowed on your tax return for that year, with the basis and holding period added to the replacement shares that you purchase.

Most experts believe that option exercises, RSU vestings, and ESPP purchases are “buys” of company stock for tax purposes. You want to watch out for monthly RSU vestings, as these will trigger a wash sale if you have also sold company stock at a loss within 30 days before or after.

Your brokerage firm will usually track and report wash sales by account. However, it may not do this across different accounts that you (and your spouse) have at the firm and at other brokers. Therefore, you and/or your tax-return preparer must consider trading activity in securities across all the accounts you have.

“The first thing I try to do is to educate my clients to avoid the issue,” chuckled webinar panelist Dan B. Hodgin, a CPA and the owner of Silicon Valley Tax Group (Campbell, CA). “But obviously that can’t always be accomplished.”

How should you track all of this? First, he said, you calculate the number of shares sold during the year. “Sometimes it looks as if clients have wash sales throughout the year, but by the end of the year they don’t. They’re all netted out. But if they do in fact have wash sales that are going to carry to a future year, you really just have to do a manual calculation. There’s really no other way.”

You report on Schedule D the wash-sale amount, which may differ from the amount on the Form 1099-B you receive from the broker, Dan explained.

“In a future year, when those shares are sold that have an adjusted basis, you’re going to adjust in the opposite direction. You want to be sure you have full backup for that. In the year when you report the wash sale, the IRS is not going to bother you or question you. They will just see less of a loss, and that’s the end of that. But in the year when you have a bigger loss than the one on the 1099-B for that year, because you are adjusting for those previous wash sales that have now been cleared out, that’s when the IRS is going to have questions.”

Dan observed that many taxpayers haven’t experienced the issue of wash sales amid the rising stock markets of the past 10 years or so. “But with down markets and 80,000 new IRS agents, I’m going to be very careful with wash sales,” he stated. “I’m going to get a full inventory of shares and track those wash sales and the basis outside the brokerage account. If they’re not tracking wash sales on RSUs or ESPPs, then you have to. It’s the only way.”

“What if wash-sale RSU shares were sold in the same calendar year?” asked a webinar attendee. “If you generate a wash sale in February or March and then sell all the shares you have by December, I’m not going to put it in,” replied Dan. “The two are just going to wash each other out. I’m going to report it only if it has a net effect on the tax return at the end of the year.”

For more details on wash sales, see another recent myStockOptions blog commentary: Selling Stock At Year-End To Harvest Losses? Don't Get Tangled In The 'Wash Sale' Rule.

Remote Work And Digital Nomads: Issues With Employee Mobility

Generally, each state you live in determines what income is taxable and when. Many companies report income to and withhold taxes for only the state where you live when restricted stock units (RSUs) vest or when you exercise nonqualified stock options (NQSOs).

However, other states where you lived during the vesting period may contact you later if its tax officials learn of this stock comp income. The state’s tax authorities may seek a proration of your compensation income for your former residence, basing their tax on the part of the vesting period during which you performed services in their state.

The general rule for sourcing and allocating stock comp income is the number of days worked in the state divided by (for RSUs) the number of days between the grant date and the vesting, or (for NQSOs) the number of days between the grant date and either the vesting or exercise date, depending on the state rules.

In the myStockOptions webinar, panelist Dan Hodgin gave some key guidance for mobile employees. “Get a travel history for the current year,” Dan recommended. “Establish a residency history for the duration of the vesting schedule.”

This is important, he explained, because you can’t necessarily trust your Form W-2 on income determination. “Payroll department staff are not tax experts,” he cautioned, “and the complexity of this issue has grown exponentially since remote working became more readily available.”

State reporting of state-sourced wages on Form W-2 can vary, he added. “New York, for example, requires state wages to equal federal wages. Sometimes the year-end paystub can provide a more accurate state breakdown.”

Once you have your records in place, compare your fact pattern to your W-2, Dan advised. “If the W-2 does not match the fact pattern, ask your company to amend it. If you can’t get the company to amend the W-2, adjust the information on the tax return. Make sure you can back up your allocation with a strong fact pattern.”

With that fact pattern documented, you will be ready for any notice from the “aggrieved” state. He also warned employees to “be wary of low- or no-tax states versus high-tax states.”

Additional Tax-Reporting Resources

The 100-minute webinar in which these tax experts spoke, Preventing Tax-Return Mistakes With Stock Comp & Stock Sales, is available on demand along with many other on-demand webinars at the myStockOptions Webinar Channel.

For guidance on the tax-return reporting for stock compensation and sales of company shares, including annotated diagrams of Form W-2, Form 8949, Schedule D, Form 3921, and Form 3922, see the myStockOptions Tax Center.

2023 Tax Planning: The 3 Numbers All Employees Should Know

Before tax-return season sets in, putting your focus on your 2022 income, this is a good time to meditate on your tax planning for 2023. That includes the federal tax-related numbers for 2023 that are crucial for all employees, their paychecks, and their planning.

The IRS and the Social Security Administration annually adjust for inflation a myriad of key numbers in federal tax-law provisions—and in 2023, given the economic cycle we're in, some of these changes are bigger than in past years. However, it can be difficult to spot the adjustments that matter to you.

Some apply only to very high-net-worth executives and other super-wealthy people. For example, there's the federal estate-tax exemption (in 2023, $12.92 million for single taxpayers and $25.84 million for married joint filers). Others of interest mainly to administrators of corporate benefit plans and other experts (like us here at myStockOptions) who keep track of this stuff. For example, the income definition of “highly compensated employee,” which affects eligibility for employee stock purchase plans (ESPPs) and 401(k) plan non-discrimination testing, is $150,000 in 2023.

This article clears away all that to focus your mind on the essential points for you. Below are the top three sets of tax figures in 2023 that all employees should know. They relate to compensation from work: paycheck withholding, the potential need for estimated taxes, and your retirement savings.

1. The Social Security Wage Base

The Social Security tax (at a rate of 6.2%) applies to wages up to a maximum amount per year that is set annually by the Social Security Administration. Income above that threshold is not subject to the Social Security tax. (By contrast, the Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level.)

In 2023, the Social Security wage cap is $160,200, up from $147,000 in 2022. This means the maximum possible Social Security withholding in 2023 is $9,932.40. Once your income is over the wage cap and you’ve maxed out the withholding, you’ll see 6.2% more in your paycheck!

2. Your Income-Tax Bracket And Withholding

If you’re an employee, your company withholds taxes from your paycheck according to the information on your Form W-4. Showing the federal income-tax brackets and their rates, the table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate, i.e. the percent of tax you pay for an additional dollar of income in your current tax bracket. That number tells you whether the withholding as indicated on your W-4 will cover the total tax you will owe for 2023. To avoid “penalizing” additional income in your mind, be sure you know your effective or average tax rate.

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies do not use your W-4 rate for this income. Instead, they apply the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly supplemental income in excess of $1 million).

As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% does not cover all of the taxes that you will owe on supplemental wage income. In that case, you must either put extra money aside for the 2023 tax return you will file in 2024, pay estimated taxes during 2023, or adjust your W-4 for your salary withholding as soon as possible to cover the shortfall. Speak with a qualified tax professional, such as a CPA or Enrolled Agent, when you’re uncertain about the best approach to take.

If estimated taxes are the route you choose, know that due dates for quarterly estimated tax payments in the 2023 tax year are April 18, June 15, and September 15 of 2023 and January 16 of 2024. (The IRS routinely postpones these due dates for taxpayers in areas of the United States affected by natural disasters. See the IRS website section Tax Relief In Disaster Situations.)

3. Your Contribution Limit For Qualified Retirement Plans

In 2023, you can elect to defer up to $22,500 from your paychecks into qualified retirement plans, such as your 401(k). That annual limit increased from $20,500 in 2022.

The total ceiling for deferrals to defined contribution retirement plans, including any extra part contributed by your employer, rose to $66,000 in 2023, a $5,000 increase over last year’s amount. If you are 50 or older, you can contribute an additional $7,500 per year, a limit that also went up in 2023.

The amount of compensation income that can be considered in the calculation for qualified deferrals grew to $330,000 in 2023. Check with your company’s 401(k) plan administrator for the process of making changes in your compensation deferral election.

Want To Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan. For more on these plans, see the website myNQDC.com.

Inflation Adjustments For Health Savings Accounts (HSAs)

While not all employees have them, health savings accounts (HSAs) are also getting an increase in their pre-tax contribution limits for 2023 in response to inflation. HSAs are available only for high-deductible health plans.

The IRS has raised the yearly contribution limit for HSA self-only coverage to $3,850, up by $200 from last year, and for family coverage it is now $7,750, up from $7,300 in 2022. The limit for HSA catch-up contributions, available for people ages 55 or older, remains $1,000. With more companies setting up pre-tax payroll deductions for HSAs and matching employee contributions, these increases could be significant for many people as the cost of health care continues its relentless rise.

IRS Resources

Here are resources with more details on the many adjusted 2023 tax numbers:

• Revenue Procedure 2022-38 gives inflation adjustments in various income-tax-related provisions for 2023, which are also summarized in a more reader-friendly IRS news release.
• IRS Notice 2022-55 gives the annual adjustments in 2023 for various tax-qualified retirement plans.
• Revenue Procedure 2022-24 has details on the HSA contribution limits for 2023.

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WEBINAR: Preventing Tax-Return Mistakes With Stock Comp & Stock Sales

Wednesday, February 15
2pm–3:40pm ET, 11am–12:40pm PT
2.0 CE credits for CFP, CPE, EA, CPWA/CIMA, CEP, ECA

This tax season brings extensive risk for mistakes with tax returns involving stock comp. Complications in tax reporting due to the volatile markets of 2022, along with more IRS agents for audits, make the need for expert tax guidance more important than ever.

Register for this lively educational webinar on tax-return topics for stock comp. In 100 minutes, it will feature insights from three tax experts on issues with tax returns involving equity comp and sales of company shares. The panelists will present real-world case studies on how to use information in tax returns to create better financial plans.

For a detailed agenda of topics covered, see the webinar registration page.

Time conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the presentation slide deck. Therefore, even if you have a time conflict, please still register, as you will receive a link to the recording and presentation.

Leading Financial Advisors Unbox Year-End Planning Amid Down And Volatile Markets Of 2022

After a tumultuous year of stock-price volatility and declines, year-end financial and tax planning in 2022 may be trickier than usual for some people with equity comp and holdings of company shares. This was the emphasis of a popular webinar we held at the start of December: Year-End 2022 Financial & Tax Planning For Equity Comp. In the spirit of the season, leading advisors with expertise in equity comp presented ideas and tips for year-end 2022 and year-start planning 2023:

• John P. Barringer (CFP®), Executive Wealth Planning
• Rebecca Conner (CPA, CFP®), Founder, SeedSafe Financial LLC
• John Owens (CFP®, EA, ECA, CPWA®), Director of Financial Planning, Brooklyn FI

The article below summarizes some of the key points they made. The webinar in which they spoke is available on demand at the myStockOptions Webinar Channel. Meanwhile, myStockOptions.com has a comprehensive section on year-end planning, including extensive articles and FAQs. Seek guidance on your specific situation from qualified tax and financial advisors.

The Importance Of Multi-Year Planning

“When we start off with a client, we begin right away with the idea of multi-year planning,” noted webinar panelist John Barringer of Executive Wealth Planning in Denver, Colorado. “We treat every meeting with clients as if it’s year-end. There are so many overlapping issues: trading windows, new grants, vesting.”

Multi-year planning is especially valuable with stock comp, as you can control the timing of stock sales and option exercises, and you know when RSUs will vest. Getting this planning right is crucial, for example, if you are considering option exercises or stock sales at the end of 2022.

For a start, you need to be aware of the 2022 and 2023 thresholds for higher tax rates on compensation income and capital gains, the phaseouts for various tax credits, and the Medicare surtax on investment income. If you believe your tax rates will be higher in 2023 and beyond, you want to consider whether to accelerate income into 2022.

Webinar panelist Rebecca Conner, the founder of SeedSafe Financial in Austin, Texas, outlined her systematic approach to multi-year planning. “What we do for all of our clients is just lay out what we expect each year and then see what we can play with,” she explained. “If they’re receiving RSUs as well as nonqualified or incentive stock options, we’ll map out RSUs over the years and where we think taxable income is going to be. Then we’ll see how we can pop other things around and fit them in over those next few years.”

Stock Option Exercises: Variables To Consider

As Rebecca acknowledged, the vesting dates of RSUs are fixed, so you can’t control when you receive RSU income at vesting. By contrast, you choose when to exercise stock options, making them a variable to play with in multi-year planning.

Example: You are a joint filer with $290,000 of taxable income in 2022 and projected taxable income of roughly the same in 2023, putting you in the 24% tax bracket. You also have a $100,000 spread on your nonqualified stock options (the grant will expire in March 2023). By exercising just enough options in 2022 to generate $50,000 of additional income (giving you $340,000 for the year), you can then exercise the remaining options in early 2023 and avoid the higher 32% tax bracket in both years.

However, many advisors emphasize that taxes should not be your only consideration in year-end planning. “At year-end, we don’t let the tax tail wag the dog,” cautioned Rebecca. “The main question is really how much cash are you willing to lose toward options? They’re never a guarantee. It’s important to recognize that this may be a moonshot. If we can treat it like a very small company stock with high volatility, what would you want to put toward that? We’ll recognize what our clients would like from that perspective.”

Other factors in planning for stock option exercises at year-end are holding periods for capital gains and your company’s stock-trading windows, as discussed by webinar panelist John Owens, Director of Financial Planning at Brooklyn FI in New York. “One of the things that’s top of mind is going through what the timeline looks like,” he said. “If you’re doing an exercise on, say, December 8, you might not be able to sell those shares for long-term capital gains next year because your company’s trading window is closed during that time. We need to understand cash-flow needs for clients and how long they actually want to hold the stock.”

Incentive Stock Options: Year-End Dilemma

The advisors emphasized that in a down market it is crucial to review incentive stock option (ISO) exercises that you made earlier in the year if you are still holding the stock. Selling that ISO stock before the year ends removes the spread at exercise from the AMT calculation, thus eliminating the need to pay the AMT on it. However, making that move also means you don’t meet the ISO holding periods for beneficial tax treatment.

Diversification In Down And Volatile Markets

The need to diversify is a common theme in all investment planning. Do the down markets and volatility of 2022 make that need more or less urgent at year-end?

“I think it really depends on what the client is anchoring to,” offered John Owens. “If they’re anchoring to a stock price that was 80% higher a year ago, it may be hard to get them to sell. But I try to spin it by saying hey, your company’s stock may be down but the broader stock market is also down, so you’re selling something at a discount to buy something at a discount. You’re still getting upside, and it’s a more diversified upside.”

The webinar panelists all said they generally recommend that clients sell RSU shares at vesting as a way to diversify out of company stock. “With our clients, we explain that diversification is something we’re going to recommend in every trading window,” asserted Rebecca Conner. “For RSUs that are vesting and available to sell immediately, we will do that from the get-go. And we’ll have that conversation during the good years as well as the bad years. It’s part of the process. Clients understand that they’re dollar-cost-averaging over a period of time.”

To those who are skeptical about this concept, she points out that loyalties to single stocks can be dangerous allies. For example, after an initial public offering (IPO), “statistically 70% of IPO companies do not get back to their initial high price,” an observation that may help to ease the client away from anchoring on that price.

Private Companies In 2022: Delayed IPOs

John Owens noted the special relevance of multi-year planning in 2022 for employees of private companies which were expecting an IPO this year that was postponed by a year or more due to economic uncertainty or other factors.

“Many clients have had delayed liquidity events this year because the IPO market has dried up,” he explained. “For clients who we now know are going to have huge liquidity events in future years, we’ve actually been looking at accelerating income into this year because their income is lower than we thought it was going to be.” This strategy, he observed, takes advantage of the client’s lower tax rate this year for any income that can be recognized now instead of later, when the rate will be higher at the time of the company’s IPO, acquisition, or other liquidity event.

Ways To Reduce Taxable Income At Year-End

What if you did have a big income spike from stock compensation this year? What are some of the ways in which you can reduce your income on other fronts to keep your 2022 income in a lower tax bracket?

John Barringer mentioned first the need to max out 401(k) plans and, beyond that, perhaps consider a contribution to a nonqualified deferred compensation plan. However, he cautioned, this type of planning should be prospective rather than retrospective. “Before that big income hit happens, we need to know how we’re going to proceed,” he urged. “By the time the event happens, if there wasn’t some planning before, it’s getting close to being too late.”

Rebecca Conner agreed. “A client will come to us with a double-trigger RSU vesting and say ‘How do I minimize taxes?’ Oh, man!” she laughed. “Not very easily. However, we can talk about ways to defer future taxes. Maybe it’s a great time to do a mega-contribution to a 529 college-savings plan for a young child. Maybe it’s time to make choices with investments now to really set you up to defer those kinds of taxes in a bigger picture over multiple years in the future.”

Tax-Loss Harvesting

One popular year-end strategy is tax-loss harvesting: you sell stock at a capital loss that can then be used on your tax return to first offset capital gains and then up to $3,000 of ordinary income. “We’re focusing a lot on tax-loss harvesting, mainly for people with huge first-time capital gains, perhaps $2–3 million payouts,” said John Owens. Rebecca Conner added that her firm is doing the same. “We look at how much a tax loss can really help clients and what we think is justifiable,” she explained. “It may help them for a lot of additional stock sales.”

But not all advisors are big fans of this technique. “I do not oversell the idea of tax-loss harvesting,” said John Barringer. “It’s not going to make a huge difference on your tax return. It’s going to lock in losses that you may or may not regret later. And there’s not a lot of bang for your buck in focusing on this when there are so many other issues to focus on with equity comp.”

If you do seek tax-loss harvesting and plan to repurchase the same stock after selling it at a loss, beware of the rules on wash sales, which are explained in an article at myStockOptions: 7 Wash Sale Facts To Know Before Selling Stock For Tax Loss Harvesting.

Year-Start Planning In 2023

Part of year-end planning is also thinking about the coming year. “What new grants do you expect in 2023?” asks John Barringer of his clients. “An ongoing down market may mean a bigger share grant or at least a lower exercise price for stock options.” You should also be aware of stock option grants that are scheduled to expire in 2023, he added, along with what would happen to stock options and RSUs if you were laid off.

John Owens pointed out that now is a great time to enroll in an employee stock purchase plan (ESPP), especially if it has “a good lookback provision for calculating the purchase price.” ESPPs with that feature can be a surprisingly profitable deal in a down market.

Rebecca Conner urges clients to think about employment prospects. “Review job expectations and career goals. If you’re making a move in 2023, 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.”

She and the other panelists also recommend evaluating whether to exercise ISOs early in the new year and hold the shares if the company’s stock price is still depressed but the outlook for the company is good. This can minimize your AMT risk while starting the holding-period clock for the beneficial ISO tax treatment.

myStockOptions Webinars

See the myStockOptions Webinar Channel for upcoming webinars and past webinars on demand. Each webinar (100 mins) offers 2.0 CE credits for CFP, CPWA/CIMA, CEP, EA (live webinars only), and CPE (live webinars only):

Year-End 2022 Financial & Tax Planning For Equity Comp. Boost your knowledge of year-end and year-start strategies for stock options, restricted stock/RSUs, ESPPs, and company stock holdings to help you make smarter decisions and prevent costly mistakes.

Restricted Stock & RSU Financial Planning: Advanced Bootcamp. Insights from a panel of three leading financial advisors, including case studies, to provide practical expertise for restricted stock/RSUs in public and private companies.

Stock Option Exercise Strategies: Advanced Bootcamp. It is crucial to have a plan for stock option exercises. This webinar features compelling strategies from a panel of three experts in financial and tax planning for option exercises.

Stock Compensation Bootcamp For Financial Advisors. Whether you are new to stock comp or want to sharpen your knowledge, our bootcamp webinar provides practical information and insights to maximize success.

Stock Comp Financial Planning For Private Company Employees: From Startup To IPO Or Acquisition. Equity comp in private companies is different. Learn the related financial and tax planning with three leading financial advisors, including real-world case studies.

"The knowledge I gained from myStockOptions both as a premium member and from your webinars has made me stand out at work." —Vincent Leonardo (EA), Tax Analyst, Intuit

Negotiating Equity Compensation: How Advisors Can Help Clients. Learn the best ways to evaluate and negotiate equity compensation in job offers and how to protect it at job termination.

Strategies For Concentrated Positions In Company Stock. Wealth is won and lost through the management of concentrated company stock positions. In this webinar, experts at managing concentrated stock wealth explain strategies and solutions.

10b5-1 Trading Plans And Other SEC Rules Advisors Need To Know. Learn the fundamentals, best practices, and most effective designs for Rule 10b5-1 trading plans. This webinar features top legal and financial experts presenting practical guidance and real-world case studies for financial advisors.

Preventing Tax-Return Errors With Stock Comp And Stock Sales. Understand the rules of tax-return reporting for stock options, restricted stock/RSUs, ESPPs, and sales of company shares. Learn how to avoid the common mistakes that can lead to overpaying taxes or unwanted IRS attention.

Selling Stock At Year-End To Harvest Losses? Don't Get Tangled In The 'Wash Sale' Rule

“Harvesting” capital losses to offset capital gains on your tax return is a popular year-end strategy. But watch out for wash sales, which can tangle up your tax planning. This article explains what you need to know to avoid this tax trap.

Tax-Loss Harvesting And Wash Sales

In brief, the tax rules let you net capital losses against capital gains on Schedule D of your Form 1040 tax return. Any unused capital losses you can then net against up to $3,000 of ordinary income. Lastly, you can then carry forward any remaining losses to the next tax year. If you think stocks will go up in 2023, you may think it makes tax sense to sell loss-makers now, before the end of 2022, and repurchase those stocks soon afterward to keep your investment in them.

For example, after the stock market declines of 2022, you may now hold securities—whether stocks, ETFs, or mutual funds—that would generate capital losses if sold. Those losses could then be used to offset capital gains and a limited amount of ordinary income.

Here’s where that crafty tax plan runs into trouble. A sale of stock at a loss coupled with the repurchase of the same stock within 30 calendar days after the sale will trigger the wash-sale rules, disallowing, for now, the capital loss. Below are key facts to understand about these rules.

Seven Points To Know About Wash Sales

1. The disallowed loss is not “lost” (with one big exception: see #4 below). Instead, the loss you’re not able to claim on your upcoming Form 1040 tax return is added to the replacement stock’s basis and holding period. If you purchase fewer shares than you sold, the wash-sale treatment applies only to that number of shares (i.e. not the entire number of shares initially sold).

2. While the timeframe for wash sales is often presented as a 30-day window, it’s actually a 61-day window covering the 30 days before and after your sale, regardless of whether that period spans two years. Buying in early January the same stock you sold at a loss at the end of December would definitely be deemed a wash sale.

3. The rules are triggered when you buy “substantially identical securities” before or after the loss. Let’s say you’re selling at a loss the stock in the company you work for but believe strongly that its price will rebound. You’re stuck with the wash-sale time limits once you sell it, and you also need to follow the insider-trading rules even before you do. You could instead buy the stock of another company in the same industry or in a mutual fund or ETF tracking that industry.

4. The wash-sale rules do not directly apply when the sale and purchase both occur in your 401(k) or IRA, as capital gains and losses are not tracked in those accounts. However, after the sale in your retail brokerage account, you cannot outfox the IRS by instead purchasing the same security in your IRA or 401(k). IRS Revenue Ruling 2008-5 goes even further: it prevents you from adding this loss to the basis of the shares purchased in your IRA. That would permanently eliminate the capital loss disallowed in the year of sale.

5. Trades involving listed options, employee stock option exercises, and shares bought through employee stock purchase plans (ESPP) or dividend reinvestment plans (DRIPs) can cause a wash sale when they occur within 30 days after you sell the stock at a loss. The treatment for incentive stock options (ISOs) is more draconian still, as a wash-sale loss is triggered even when you sell the ISO stock at a price higher than the exercise price but lower than the market price on the date of exercise. For restricted stock or restricted stock units, the grant itself or its vesting may also trigger the wash-sale rules when you have sold stock at a loss, as explained by an FAQ at myStockOptions.com.

6. Your brokerage firm will track and report wash sales by account. It may not do this across different accounts that you (and your spouse) have at the firm and at other brokers. Therefore, you and/or your tax-return preparer must consider trading activity in securities across all the accounts you have.

7. Form 1099-B, which you receive from your broker in time for tax season (usually by Feb. 15), reports all of your stock sales from the prior year. It shows (in Box 1g) the amount of any nondeductible loss stemming from a wash sale involving covered securities (at least for those in the same account). Note that many brokerage firms reformat Form 1099-B into their own substitute statement that has columns labeled the same as the boxes on the IRS form. You still need to report the wash sale on your tax return on Form 8949, even though the loss on those shares will not be immediately recognized, and adjust the tax basis on the replacement shares when you sell them.

More Tax Resources

See IRS Publication 550 for the IRS guidance on wash sales. It appears in the subsection “Capital Gains & Losses” of Chapter 4 (pages 56–57 in the version for 2021 tax returns).

When your tax planning (and your tax return) for 2022 involves income from company stock sales and/or equity compensation, such as stock options, restricted stock units, or ESPPs, explore the Tax Center at myStockOptions.com and consult a qualified tax or financial advisor. We have articles, FAQs, videos, and annotated IRS forms that demystify the complex federal tax rules. On December 1, myStockOptions.com is also holding a webinar on year-end and year-start financial planning and tax strategies for equity comp (see section below).

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WEBINAR: Year-End 2022 Financial & Tax Planning For Equity Comp

Thursday, December 1, 2022
2:00pm to 3:40pm ET (11:00am to 12:40pm PT)
2.0 CE credits for CFP, CPE, EA, CPWA/CIMA, and CEP

In this lively webinar, boost your knowledge of year-end and year-start strategies for stock options, restricted stock/RSUs, ESPPs, and company stock holdings to help you make smarter decisions and prevent costly mistakes. Volatile markets and economic uncertainty make the need for effective guidance even more important, as this webinar will cover.

In 100 minutes, the webinar features insights from a panel of three leading financial and tax advisors, including real-world case studies, to provide practical expertise on equity comp in both public and private companies. Minimize taxes and build wealth with their know-how on the essentials of year-end and year-start planning.

Time/date conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the detailed presentation slide deck and handouts.

Agenda and panelist details are available at the webinar registration page.

"The knowledge I gained from myStockOptions, both as a premium member and from your webinars, has made me stand out at work." —Vincent Leonardo (EA), Tax Analyst, Intuit

Stock Options & RSUs: 6 Pro Tips For Navigating Volatility

For many of you who have equity comp, the extreme market fluctuations of 2020–2022 may be your first experience of volatility after a decade of rising markets. Know that it's normal to feel a little rattled. Sudden stock-price declines can stress out even the most experienced holders of stock comp (and their financial advisors).

Sooner or later, volatility may force you to make decisions that affect your financial future and long-term wealth. Should you change your financial plan or stick with it?

Financial strategies for equity compensation amid volatility and falling stock prices were dominant themes in two recent myStockOptions webinars. In one webinar on stock option exercise strategies and another on planning for restricted stock and RSUs, panels of financial advisors and tax experts discussed how to navigate volatility and down markets. This diverse group, including CFPs, EAs, and JDs, presented a variety of insights from different angles.

1. Listen To Your Risk Tolerance

David Marsh, a financial-planning case manager at Ameriprise (Minneapolis), pointed out in the stock option webinar that market declines offer a useful period to “confirm or reset risk tolerance.” In good times for your company’s stock price, he observed, it’s easy to be aggressive and bullish in your financial strategy. It’s harder to keep up that resolve when the stock price tumbles. In fact, he continued, a falling stock price can give you a helpful reality check on your tolerance for investment risk.

He suggests you listen to what your emotions in a downturn are telling you. “How much of a downturn are you willing and able to stomach, and how does that impact your goals? If you’ve been relying on equity comp to meet regular living expenses, that’s a real danger zone which comes to light in stock-price volatility and downturns.” Insights you derive from dark times for the stock price can help you re-examine your goals for share proceeds and re-assess the portion of them that is discretionary.

With nonqualified stock options, he went on, a reduction in the difference between the stock price and the exercise price may seem to create a tempting opportunity to exercise the options. That starts the holding period for the beneficial tax treatment on long-term capital gains at sale when the stock price eventually recovers. This is a common strategy for incentive stock options (ISOs).

However, with nonqualified stock options (NQSOs) there may be better uses for the same money. “You should compare whether to exercise and hold NQSOs or maybe just hold on to that option and put the cash to work in another way,” he advised. “Consider investment risk and tax factors. What I would bear in mind is that if you’re game enough to exercise NQSOs at this time, I would say let’s take that cash and simply buy more shares. If indeed the stock price does recover, by increasing the equity position in the company we may produce a better result.”

2. Welcome New Option Grants, But Have A Layoff Plan

Megan Gorman, the founder of Chequers Financial Management (San Francisco), complemented David’s thoughts in the stock option webinar with the fact that a depressed stock price is an excellent time to get new stock option grants. Playing a long game, she emphasized, is key to success with equity compensation. “If you go back to March 2009, when the stock market was miserable, it was an amazing time to get a grant with a very low exercise price,” she observed. The stock-price increases during the long recovery made option grants awarded at that time extremely wealth-generating.

But beware of layoffs, she cautioned. Option grants have finite terms and typically only very short periods when options can be exercised after job termination. “It’s important to have a strategy for exercising options and selling stock in the event you are laid off. In these more volatile markets, think about the fact that you are at risk of losing your job. Don’t lose the equity awards you worked so hard for.”

3. Don’t Forget The Big Picture, But Revisit Your Cash Position

Keep your big-picture financial goals in mind, advised Chloé Moore, the founder of Financial Staples (Atlanta), in the restricted stock/RSU webinar. “Things are a little volatile now, but keep a handle on your financial goals. Focus on what you can control: continue to build savings, pay off debt, and put yourself in a stronger financial position to shield yourself as much as you can from the impact of volatile markets.”

To that end, now is a good time to increase your cash position, she noted. “Your restricted stock units can help with this,” she points out. “That’s a good reason to sell the shares as soon as the stock vests.” If you’re using your RSUs to fund your lifestyle, it’s crucial “to revisit cash flow,” she asserted.

4. Try To Be Logical Rather Than Emotional

This is often easier said than done, but it’s an attitude worth reinforcing. In the RSU webinar, Meg Bartelt, the founder of Flow Financial Planning (Bellingham, Washington), addressed the irrational tendency to place too much importance on the grant price of restricted stock/RSUs. If the stock price falls between grant and vesting, this mental “anchoring” makes it easy to feel as if you’ve lost something.

“If you received Google RSUs a year ago, the much higher grant value is really depressing now,” she mentioned as an example. “Your projected comp used to be $500,000. Now it’s $300,000. But it’s important to remember that the $500,000 was literally never yours. The only thing that is yours is the number of shares, if you stick around long enough at the company. Be aware of that bias.”

Should you hold your RSU shares or sell them? The test for answering this question, Meg pointed out, “doesn’t change with the stock price.” Rather, she went on, it’s always this: “If you had cash of the same amount, would you buy stock in the same company?” If the answer is yes, you probably want to hold your shares. If the answer is no, you probably want to sell them. “The answer may change with the stock price and market conditions, but not the logical framework,” she emphasized.

Daniel Zajac, the managing partner of Zajac Group (Exton, Pennsylvania), brought up an alternative approach to minimize downside risk in volatile markets if you have both stock options and RSUs. Speaking alongside Meg and Chloé in the RSU webinar, he suggested doing an analysis to determine whether it makes sense for you to hold your vested RSU shares and instead exercise your options and sell those shares. That can safeguard the generation of proceeds you need for specific goals.

5. Watch Your Estimated Taxes; Look Ahead To Future Grants

Meg also observed that a big drop in income between last year and this year means that if you pay estimated tax to keep up with income spikes from RSU vestings, you should revisit how much estimated tax you’re paying. “Estimated tax vouchers for the current tax year are based on last year’s income. If you use last year’s estimated tax vouchers for this year’s lower income, you’re going to be way overpaying estimated taxes this year.”

The inverse is also true, she continued, should you lower your estimated tax payments this year. If the stock price goes back up next year, you want to be sure you’re not underpaying estimated taxes on the basis of your lower income this year.

Daniel echoed Meg’s observations by stressing the importance of “actively working with a CPA” to be sure that you’re neither overpaying nor underpaying estimated tax throughout the year, instead of simply relying on the safe harbors based on your prior year’s income. “If you have significant equity comp,” he stated, “you should be doing quarterly check-ins for estimated taxes.”

Daniel and the other presenters in the RSU webinar also pointed out that a fallen stock price presents new opportunities. If your annual equity comp grants are based on a percentage of your salary, “you may be getting additional shares because the stock price is lower.” This is good news to offset the bad news of a lower stock price.

6. Now Is The Time To Seek Professional Financial Advice

Bill Dillhoefer, the CEO of Net Worth Strategies (Bend, Oregon), which developed the StockOpter analysis tool, urges employees with equity comp in a downturn to seek advice from a professional financial planner, if they haven’t already. “When the stock price is going up, you may be getting advice from the watercooler chat and think you don’t need a financial advisor,” he said in the stock option webinar. Confidence is easy in bull markets. However, the game changes when stock prices tank and a bear market looms.

Bill emphasized how much a financial advisor can help you make better decisions and avoid mistakes with stock compensation. A good advisor can “establish and track diversification criteria based on risk.” He recommended understanding your “forfeit value,” a metric an advisor can calculate that shows the value lost if you leave your company to work for a competitor. Even if you’re generally confident in your knowledge of personal finance, advisors can help you “be a little more secure about lasting through these volatile markets without going crazy.”

Further Resources

The webinars in which these financial-planning experts spoke are available on demand at the myStockOptions Webinar Channel:

• Stock Option Exercise Strategies: Advanced Bootcamp
• Restricted Stock & RSU Financial Planning: Advanced Bootcamp

myStockOptions.com has other resources and tools on financial planning amid volatility and down markets.

Year-End Planning 2021: 6 Items For Your Stock Comp Checklist

Year-end financial and tax planning comes around every December like old favorite holiday movies. Strategies for year-end 2021 and year-start 2022 are especially crucial for the millions of employees in the United States who have stock compensation such as stock options and restricted stock units (RSUs), participate in an employee stock purchase plan (ESPP), and/or have holdings of company shares.

To help keep the season merry and bright, myStockOptions.com recently held a webinar on year-end planning with a panel of three financial and tax advisors who have expertise in stock compensation. Some of their insights are summarized in the year-end checklist below.

1. Should You Plan For Tax-Law Changes By Congress?

The future of new tax legislation in Congress is not clear enough to provide definite direction for year-end planning, according to the webinar panelists. The version of the Build Back Better Act passed by the House of Representatives in November did not include some of the tax hikes previously on the table to raise ordinary income and capital gains rates and change the estate and gift tax.

But it does include other tax provisions to keep an eye on that could impact equity compensation or stock sales. For example, it seeks to allow SALT (property and state tax) itemized deductions up to $80,000 (currently limited to $10,000). This change would affect tax planning when you have incentive stock options (ISOs) and want to avoid the alternative minimum tax.

Another major proposal in the bill is a surtax of up to 8% on the very wealthy. For individuals, this provision would impose a surcharge of 5% for modified adjusted gross income (MAGI) of more than $10 million, plus an additional 3% on MAGI over $25 million. This creates the equivalent of a top long-term capital gains rate of 28.8% or 31.8% that would apply to stock sales.

The bill also seeks to limit the qualified small business stock (QSBS) income exclusion to 50% for sales after September 13, 2021, for individuals with adjusted gross income of at least $400,000 and for all trusts and estates. This is a special tax benefit when you have stock compensation, founder’s stock, or investments in a private company and have held the shares at least five years, plus meet other requirements. The QSBS exclusion has been 100% for QSBS up to $10 million over the past several years.

“If this goes through, it’s basically going to negate any benefits of qualified small business stock,” lamented webinar panelist Chun Wong, Managing Partner of the CPA and accounting firm Safe Harbor LLP in San Francisco. He explained that a 50% exclusion would raise problems with the alternative minimum tax (AMT), depending on when the stock was acquired.

However, the future of the bill is too uncertain to be a factor in year-end tax planning. “The legislation currently in Congress is out of your control,” asserted Ally-Jane (AJ) Ayers, a CFP, CEP, and Enrolled Agent who co-founded the financial-planning firm Brooklyn FI in New York. “There’s so much we don’t know that at this point in the year, the best you can do is make a goals-based decision or a risk-based decision. We shouldn’t make tax decisions about what may or may not happen in Congress this year. The best thing to do is to make decisions about what your family needs for liquidity and financial independence.”

2. Income-Shifting And Multi-Year Planning

Multi-year planning is especially valuable with equity compensation, given the spikes of income that can occur with option exercises, the vesting of restricted stock/RSUs, or company stock sales. In general, you want to keep your yearly income under the thresholds for higher taxes and try to recognize extra income in the year when your income and tax rates will be lower.

Be aware of the 2021 and 2022 thresholds for higher tax rates on compensation income and capital gains, the phaseouts for various tax credits, and the Medicare surtax on investment income. The table below presents key income thresholds in 2021 that affect your tax rates.

TAX RATE/IMPACT	INCOME THRESHOLD
Income taxed at 37%	(single) over $523,600 (joint) over $628,300 (taxable income)
Other upper income tax rates for compensation income and short-term capital gains (22%, 24%, 32%, 35%)	Single: taxable income starting at $40,526 (22%) $86,376 (24%) $164,926 (32%) $209,426 (35%) Joint: taxable income starting at $81,051 (22%) $172,751 (24%) $329,851 (32%) $418,851 (35%)
Capital gains (long-term) and dividends (qualified) taxed at 15% or 20%	15% rate when taxable income: (single) $40,401 through $445,850 (joint) $80,801 through $501,600 20% rate when taxable income: (single) over $445,850 (joint) over $501,600
3.8% Medicare surtax on investment income; additional 0.9% Medicare tax on compensation income	$200,000 single $250,000 joint (modified adjusted gross income)

“The primary place where I see multi-year planning in my practice is for employees who have ownership guidelines as part of their employment contract and use RSU vestings and other ways to acquire the stock to meet them,” observed webinar panelist John Barringer, a CFP and the Managing Partner of Executive Wealth Planning in Denver. “Spreading out stock option exercises over a number of years to increase their stock ownership can smooth out the tax consequences.”

“Where we see multi-year planning the most is for clients who are going to make a big life change,” said AJ Ayers of Brooklyn FI. “For example, if they’re planning to switch jobs or add/remove a spouse from the tax return, those are opportunities for very large income swings. If we have a CMO at a company that just went public making $350,000 a year and they want to take a sabbatical next year, perhaps we can shift NQSO exercises into next year when we are nearly certain their tax rate will be lower.”

However, the advisors warn against making taxes the only reason for taking year-end action on stock comp. “I have to remind clients year after year to not let tax considerations be the primary driver of exercise timing,” explained John Barringer. “That being said, when you have options that are deep in the money or close to expiration, if you squeeze out a little bit of exercise now and still stay in the same tax bracket, that’s probably a good plan. If you run the risk of exercising in the next year, bear in mind that the differential in tax brackets could easily be erased by a couple of bad weeks of market behavior. Down markets don’t care about your tax treatment.”

“I would put need to diversify first,” added AJ Ayers. “As opposed to what the client thinks the stock is going to do, we ask what are the client’s goals? How quickly do they want to reach financial independence or retirement, and how does that impact our multi-year strategy to diversify?”

3. Withholding May Not Cover Taxes Owed

The flat supplemental wage rate for federal income tax withholding on stock compensation is based on the seven federal income-tax brackets. For amounts over $1 million, it is linked to the highest rate (37%). For amounts up to $1 million, it is linked to the third rate (22%), which is relatively low for most people with equity comp. Often those employees are underwithheld.

In fact, the 22% rate of withholding typically does not cover the actual taxes you will owe on the additional taxable income from your exercise of nonqualified stock options or vesting of restricted stock/RSUs. You must therefore know the tax bracket for your total income and assess the need to (1) put money aside to cover the taxes, (2) pay estimated taxes, or (3) revise your W-4 for the remainder of the year to increase salary withholding. Plus, with ISOs, while you have no withholding at exercise or sale, you will still owe taxes for the income triggered.

“My favorite way to handle this would be to just make changes in the W-4 and withhold extra every other paycheck,” said AJ Ayers. “Unfortunately, with the size of RSU vests, typically that’s not possible. They would have to withhold their entire paycheck and then some. So we find that making quarterly estimated tax payments is the best way to handle this.”

“We set our clients up with protective estimates,” noted Chun Wong. “If there is an event where the client has to pay more, such as at the end of the year, we’ll make an adjustment on what has to be paid on an estimate or W-2 withholding.”

4. Incentive Stock Options

Thinking about exercising incentive stock options (ISOs) before the end of the year and then holding the stock? While you must hold ISO shares for more than one year from exercise and two years from grant to get their beneficial tax treatment, you need to understand that the ISO exercise-and-hold beyond the year of exercise can also expose you to the alternative minimum tax (AMT). If the stock price falls significantly, you could be stuck with a big AMT bill on paper gains that is greater than the actual total value of the shares.

Be sure that you and your tax advisor first prepare an AMT projection to determine your AMT crossover point and see whether a tax benefit may arise from waiting until January of the following year. Next year the exercise may not trigger the AMT. Exercising ISOs at year-start can be a wiser move anyway. You then have all year to see how the stock performs and decide whether to hold the ISO shares beyond the year of exercise or sell before year-end to avoid the AMT in what is called a disqualifying disposition.

“We often will disqualify some ISOs to provide liquidity,” explained AJ Ayers. “As we disqualify ISOs, we bring up ordinary income. That creates a bigger budget to exercise additional ISOs and not generate any more AMT in the future.”

5. Year-End Planning For Pre-IPO And IPO Companies

Special year-end considerations arise for employees with stock comp at newly public companies or those announcing an upcoming IPO. You need to know:

• when the post-IPO lockup or other stock resale restrictions will end
• whether you have any ability to sell some shares sooner
• when shares will be delivered with double-trigger vesting RSUs

“One of the first things I tell my clients is to find out who the stock plan administrator is,” said AJ Ayers. “For clients who are experiencing an IPO, a direct listing, or a SPAC, having a direct line to someone who actually knows what’s going on will be the most valuable thing. Often companies are just not prepared to give these answers.”

AJ went on to offer some key points for clients at private companies who are expecting the company to go public soon.

• Be wary of companies going public in Q4 of the current tax year. If you have an RSU grant, it may start vesting and will therefore increase ordinary income.
• If you are going to be subject to blackout periods when the company prohibits sales to prevent insider trading, you may want to break the general wisdom of not exercising ISOs late in the year so you can start the one-year holding clock for a 2022 qualifying disposition and attempt to catch the Q4 trading window.
• Be prepared to run a few different tax-planning scenarios to show how disqualifying ISOs can lead to a favorable outcome if you are in danger of paying a large amount of AMT.
• The year before an IPO can be a fantastic opportunity for charitable donations, especially if you made ISO disqualifying dispositions that bump up your income.

6. Confirm Dates For Exercise And Vesting: 2021 Or 2022?

This last point here may seem little, but it can have big implications. Stock option income recognized on an exercise date in 2021, and restricted stock/RSU income with a vesting date in 2021, will be included in 2021 taxable income and on your W-2 for 2021. It does not matter that the company won’t send the taxes to the IRS until early January.

However, January 1 of 2022 falls on a Saturday, meaning that for many companies December 31 (i.e. Friday) is a holiday. Therefore, you will want to confirm how your company handles exercises that occur on or vestings scheduled for December 31, 2021. Will the transaction revert to the previous business day or the next business day? You also want to confirm whether December 30 (Thursday) or December 31 (Friday) is considered by your company and your stock plan to be the last business day of 2021 (and if it’s Dec. 31 whether up to a certain time).

Further Resources

The year-end planning section on myStockOptions.com also has articles by experts and FAQs on these topics and more. The webinar in which these advisors spoke is available on demand at the myStockOptions Webinar Channel. In addition to what’s covered in this article, the advisors presented case studies highlighting many of the planning issues they focus on at year-end for public and private company clients.

myStockOptions Webinar Channel

See the myStockOptions Webinar Channel for upcoming webinars and past webinars on demand. Each on-demand webinar (100 mins) offers 2.0 CE credits for CFP, CPWA/CIMA, and CEP:

Year-End 2021 Financial Planning For Equity Comp: Sharpen your knowledge of year-end and year-beginning financial and tax strategies for stock comp and company shares with insights from a panel of three leading financial advisors, including real-world case studies, to provide practical info, guidance, and expertise for equity comp in both public and private companies.

Stock Comp Financial Planning For Private Company Employees: From Startup To IPO Or Acquisition: Equity comp in private companies is different. Learn the related financial and tax planning with three leading financial advisors, including real-world case studies.

Restricted Stock & RSU Financial Planning: Advanced Bootcamp: Insights from a panel of three leading financial advisors, including case studies, to provide practical expertise for restricted stock/RSUs in public and private companies.

Stock Option Exercise Strategies: Advanced Bootcamp: It is crucial to have a plan for stock option exercises. This webinar features compelling strategies from a panel of three experts in financial and tax planning for option exercises.

Stock Compensation Bootcamp For Financial Advisors: Whether you are new to stock comp or want to sharpen your knowledge, our bootcamp webinar provides practical information and insights to maximize success.

Strategies For Concentrated Positions In Company Stock: Wealth is won and lost through the management of concentrated company stock positions. In this webinar, experts at managing concentrated stock wealth explain strategies and solutions.

10b5-1 Trading Plans And Other SEC Rules Advisors Need To Know: Learn the fundamentals, best practices, and most effective designs for Rule 10b5-1 trading plans. This webinar features top legal and financial experts presenting practical guidance and real-world case studies for financial advisors.

NQDC Alert: New 2022 IRS Limits For Qualified Plans Affect Deferral Planning

For participants in nonqualified deferred compensation (NQDC) plans, it's time again to make like an autumn squirrel and decide how much to store for the future.

In November and December, many executives and key employees who participate in NQDC plans must decide how much of next year's salary to defer. Factors in this decision about nonqualified plans include the IRS limits that apply to qualified retirement plans (and this year also the outlook for future tax rates under legislation in Congress). The IRS just set the qualified plan limits for 2022.

As explained at our sibling website myNQDC.com, the contribution limits of qualified plans are the major reason for the existence of nonqualified plans: to allow executives and key employees to squirrel away additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan.

The IRS changes in limits from 2021 to 2022 are relatively small. If you've already maxed out your qualified plan contributions for 2021, you will probably do the same in 2022, so you will need NQDC plans to defer any salary and bonus increases you expect in 2022. Also, depending on tax legislation in Congress, there may be higher tax rates in 2022 and/or beyond, increasing the need to defer income.

Contribution type/limit	2021	2022
Compensation allowed in qualified deferral and match calculation	$290,000	$305,000
Elective compensation deferrals	$19,500	$20,500
Catchup contributions for people aged 50 or older	$6,500	$6,500
Total defined contribution limits (employee and employer contributions)	$58,000 + catchup contribution	$61,000 + catchup contribution
Defined benefit plan payout limits	$230,000	$245,000
Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation	$185,000	$200,000
Income threshold defining highly compensated employees for the purposes of nondiscrimination testing; this also applies to the income point where companies can exclude employees from a tax-qualified ESPP	$130,000	$135,000

Set by the Social Security Administration, the Social Security wage cap will rise in 2022 to $147,000, a slight increase from $142,800 in 2021. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $8,853.60 in 2021 and will rise to $9,114 in 2022. Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral, as shown by an FAQ at myNQDC with an annotated diagram of Form W-2 showing where these amounts are included.

For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC. See also our FAQ on the top NQDC-related year-end-planning issues.

Stock Options & RSUs: 5 Costly Mistakes To Avoid

Stock compensation is complex: make no mistake about it. However, that's easier said than done. It's actually all too easy to make costly mistakes with grants of stock options or restricted stock/RSUs, and the related taxation.

In two myStockOptions “advanced bootcamp” webinars this summer, leading experts in stock options and RSUs discussed equity comp blunders to avoid, among many other topics (Stock Option Exercise Strategies and Restricted Stock & RSU Financial Planning). This article covers five common mistakes as explained by these webinar panelists.

Mistake No. 1: Not Understanding Your Grant Or How It Works

This point may seem obvious, but you’d be surprised. Employees sometimes tell their financial advisors they have “stock options” but upon inspection of the plan documents it turns out they have another type of equity comp. So, first of all, confirm which type of equity grant you have.

A related mistake is simply failing to read all the stock plan documents and not fully understanding the terms of the grant. Study up on them. “Grant info needs to be organized, saved, and updated to provide ongoing guidance,” suggests Bill Dillhoefer, the CEO of Net Worth Strategies, the company behind the StockOpter equity compensation analysis applications for financial advisors.

Crucially, understand that stock options have a set period during which they can be exercised after vesting. When the option term ends, unexercised stock options expire and are irrecoverable. Understand the timeframe of your stock options and steps you must follow so that you’re not caught in a scramble to exercise on the final day before expiration. You do not want to let valuable in-the-money stock options expire.

RSUs bring some different planning factors. “Roughly how much will each vested amount be worth, pre- and after-tax?” asks Meg Bartelt of Flow Financial Planning. As an advisor who works with clients at pre-IPO and newly public companies, she also considers the special traits of RSU grants made by private companies. With her clients, she evaluates whether simply working at the company for a specified length of time after the grant is enough for the shares to vest or whether the stock plan requires a second vesting trigger involving a liquidity event (i.e. IPO or acquisition by a public company).

Mistake No. 2: Not Understanding The Taxes Or Letting Taxes Drive Decisions

You need to understand the taxation of your grants before you do anything with them. The tax treatment is crucial for both avoiding IRS problems and making the most of your gains. At the same time, the financial advisors all caution, understanding the taxation doesn’t mean taxes should be the principal driver of decisions.

“While taxes are key factors, it’s dangerous to base decisions principally on tax aspects and neglect coordination with goals and investment risk,” warns David Marsh, a Financial Planning Case Manager at Ameriprise.

In other words, “the tax tail should not wag the option dog,” says Megan Gorman of Chequers Financial Management. However, she acknowledges, “to build wealth, you have to deal with tax consequences.” So how do you get the balance right?

Model tax scenarios for your stock options and be prepared, Megan advises. For example, she points out that you should “be prepared for your company’s tax withholding to not be sufficient to cover your tax bill.” The IRS default flat withholding rate of 22% for supplemental wage income, such as the spread at option exercise or restricted stock unit (RSU) vesting, is often lower than your actual income-tax rate, she observes.

While the withholding rate jumps to 37% for supplemental wage income in excess of $1 million during the calendar year, employees between those extremes still need to pay the taxes not covered by the 22% default rate. The shortfall can be paid in quarterly estimated taxes based on the amount owed, among other methods.

Stock options aren’t the only equity awards with tricky taxes. Mistakes with the taxation of RSUs can also be very costly. “The worst-case scenario with RSUs, in my opinion, is that you lose money on them,” says Meg Bartelt. “And that’s a possibility if you do not sell enough RSUs immediately to cover your full tax bill.” The concern? The stock price could suddenly fall after vesting. “The bottom line is that if the stock price drops enough after the initial withholding of 22% before you sell more shares to pay your taxes, then the shares you still have can be worth less than the taxes you still owe.”

“Get ahead of the game by preparing a projected tax return to see the impact of vesting RSUs on your tax return,” advises Daniel Zajac, co-founder of Zajac Group. “Consider ways to defer other income and/or increase deductions to reduce the spike in your taxable income,” he adds. “For example, increase 401(k) contributions, participate in a nonqualified deferred compensation plan, make bigger charitable donations, or separately increase salary withholding.”

Lastly, watch your tax bracket. Stock compensation can push your income for the year into a higher bracket, leading to more taxes—something that careful timing of option exercises and RSU vestings can avoid. “The total picture of your grants is really important,” says Daniel Zajac. “I’ve seen clients create cash by exercising and selling nonqualified stock options when they’ve just had RSUs vest. That could needlessly push them into a higher tax bracket.”

Mistake No. 3: Forfeiting Your Grant In Job Termination

If you leave your company, the vesting of your stock options stops and the term usually ends early, requiring you to exercise the options soon after your departure to prevent forfeiture. These rules and timeframes can vary according to the reason you left work (e.g. job change, disability, death, retirement).

Chief among the option terms to know are the vesting provisions and what would happen upon job termination, which usually triggers a very short window for option exercise before the grant term expires. “It’s crucial to clarify equity awards’ terms for vesting and at separation of service,” says David Marsh of Ameriprise. “Realize they may not all be the same.”

As for restricted stock units, job termination stops the vesting of RSUs. So if you have a big vesting date coming up, you may want to stick around for it before any planned job change or retirement.

Other types of job terminations and life events may affect vesting differently. “How do leave of absence, disability, death, acquisition of your company, etc. affect the vesting schedule?” is something Chloé Moore, founder of Financial Staples, wants her clients to understand and communicate.

David Marsh lamented that many optionholders neglect to designate a beneficiary for vested stock options in case of death. “This is usually allowed in the plan, but often employees are unaware of that.” Also be sure that beneficiaries and executors of your estate know the option exercise deadlines.

Mistake No. 4: Not Having A Strategic Plan For The Shares

When you exercise stock options or when your RSUs vest, a big mistake is not having a plan ready to go for your newly acquired shares.

Overconcentration in company stock is a major danger employees face with shares they get from equity awards. Loyalty to your company’s stock can work against you if too much of your wealth is tied up in the stock and the price then drops. “It’s amazing to me how many times clients who understand they have a lot of company stock lose track of how concentrated they are and how movements in the stock price and new grants affect that concentration,” says David Marsh. “That’s a particular blind spot,” he warns.

Indeed, it would be hard to find a financial advisor who doesn’t extoll the virtues of diversification. “Investments that are diversified—your money is invested a little bit in a lot of different stocks or bonds—perform better, on average, than investments that are concentrated in one stock,” points out Meg Bartelt.

She often advises clients with just-vested RSU shares to sell all the stock. “Let’s say your RSUs are worth $100,000 when they vest. If I gave you $100,000 in cash income instead, would you go out and use that money to buy your company stock? If your answer is no, then that is literally the same, financially, as selling all your RSU shares.”

In her view, “you’re better off selling them all and using the money immediately for some current need (such as a down payment on a house) or other financial opportunity (such as paying off debt), or investing the money in a broadly diversified, low-cost portfolio.”

Chloé Moore has helped many clients strategize for RSU vesting. In one example that she presented during her webinar segment, her approach included:

• Allocated monthly savings, cash bonuses, and sign-on bonus to short-term savings goals.
• Kept 25% of shares that vested after the one-year anniversary (about 30% of the portfolio and a smaller percentage as the portfolio grew).
• Set aside reserves to pay the tax bill (worked with a CPA to estimate each year’s tax liability).
• Sold remaining shares as they vested and split the proceeds between student loans and savings goals, then eventually a diversified taxable account.

Daniel Zajac often suggests that his clients establish a sell schedule. “One strategy that may balance the decision to immediately retain 100% of the shares or sell 100% is to implement a plan that sells a certain number or percentage of shares over a set period. Setting a sell schedule allows you to intentionally reduce your company stock according to a formula. That removes some of the emotional decision-making from the process. You don’t need to guess what the stock price will do next, or decide you will sell when the price reaches X per share, but change your plans once the price does hit that point. You then risk the price going back down before you do sell.”

Mistake No. 5: Getting Bad Advice On Financial And Tax Planning

Stock compensation is a complex employee benefit. “Complex benefits require us to move slowly and think through issues,” says Megan Gorman. She implores employees with equity comp to obtain guidance from a qualified financial advisor and/or tax expert, and to avoid relying on tips from co-workers. Bill Dillhoefer echoed this sentiment, observing that applying advice from “water-cooler” chats with co-workers can lead to mistakes.

Everyone’s individual circumstances differ. Identifying strategies that work for you is yet another good reason to consult a financial planner. “Strategies are incredibly personal,” agrees Megan. “For your own unique situation, you may need to do very different things than your colleagues.”

Further Resources

On myStockOptions.com, the online educational resource with content and tools devoted to all things equity comp, employees and their financial advisors can prepare for stock option exercises and RSU vesting. For more on mistake prevention, see the following articles:

• How To Avoid The Most Common Stock Option Mistakes by wealth advisor Beth Walker
• How To Avoid Mistakes And Create Wealth With Your Stock Options by CFP Paul Palazzo

In addition, all of the financial advisors quoted in this article have discussed planning strategies in detail during webinars that are available on demand at the myStockOptions Webinar Channel.

 

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WEBINAR: Stock Comp Financial Planning For Private Company Employees: From Startup To IPO Or Acquisition

• Sept. 22, 2pm–3:40pm ET, 11am–12:40pm PT
• 2.0 CE credits for CFP, CPWA/CIMA, CEP, and EA

Initial public offerings (IPOs) are booming as fast-growing private companies go public. Important wealth-building and tax-minimizing decisions are faced by employees and executives at private companies who have stock options, restricted stock, restricted stock units (RSUs), or founder's stock.

In 100 minutes, this webinar covers the fundamentals of private company stock grants and related strategies for financial and tax planning that can help advisors serve these clients effectively, build wealth, and prevent expensive mistakes. The webinar features three leading financial advisors presenting practical guidance and real-world case studies. Their insights and expertise apply to clients at both startups and later-stage private companies, from the time of grant until the company goes public or is acquired.

For a detailed agenda of topics covered, see the webinar registration page.

Time conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the presentation slide deck. Therefore, even if you have a time conflict, please still register, as you will receive a link to the recording and presentation.

4 Ways Biden's Tax Proposals Could Affect Stock Comp Financial Planning

Millions of employees in the United States have stock compensation and/or holdings of their companies' shares. Many of them may be depending on these for major financial goals, such as a buying a house, saving for retirement, or funding children's college tuition. Could President Biden’s proposed tax changes impact their gains and their financial planning?

The short answer: yes, they very well could, depending on your income. While the future of the proposals remains highly uncertain, some of the proposed tax increases, such as a major hike in the top rate of capital gains tax, may require you to take action well before any new tax legislation is adopted.

The proposed tax provisions to follow are in the American Jobs Plan and the American Families Plan. The US Treasury’s General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, known informally as the “Green Book,” provides a summary and rationale of the tax changes.

Don’t have time to read Congressional legislation or a tome written by the US Treasury? No problem. At myStockOptions, we read that stuff so you don’t have to, along with related commentaries from law firms and other expert observers. Below is what to know about the potential impact of Biden’s tax proposals on stock compensation and company shares that you hold. For financial advisors, this provides an opportunity to reach out to clients about the possible changes and the impact on decisions involving stock options, restricted stock, ESPPs, and company stock holdings.

1. Top Tax Rate

Currently, the flat supplemental wage withholding rate, which applies to income such as stock compensation and cash bonuses, is 22% for yearly amounts up to $1 million and 37% for yearly amounts in excess of $1 million. That higher withholding rate is tied to the top tax bracket.

Under Biden’s plan, the highest ordinary tax bracket rate would go from 37% to 39.6% starting January 1, 2022 (see page 60 of the Green Book). That would therefore increase the higher rate of supplemental wage withholding to 39.6%. This rate would also apply to short-term capital gains for anyone in the top tax bracket.

ACTION STEPS: When you decide to exercise nonqualified stock options (NQSOs), you control when you will realize the taxable income at exercise, including federal tax. If you’re in the top tax bracket or will be from your option exercise, analyze whether for tax reasons it makes sense to exercise the options in 2021 instead of in 2022, when that bracket rate may be higher.

While most financial advisors would not suggest you make stock option exercise decisions solely for a 2.6% tax savings, this potential tax hike is worth evaluating as a factor for options close to expiration. For options not close to expiration, remember that NQSOs offer substantial leverage and upside, all of which ends as soon as you exercise the options (see the prior article in this blog).

Private companies with a recent or upcoming initial public offering (IPO) have a special concern. If your company has granted double-trigger-vesting restricted stock units (RSUs), in which typically the shares are not fully vested and delivered until six months after the IPO, the company may want to consider accelerating the share delivery into 2021 should the change to the top income-tax bracket be enacted. Accelerating that income into 2021 by delivering the shares this year (when the top rate is 37%) will save taxes for employees who have already met the requirements of both the time-based and the liquidity-event vesting conditions.

2. Capital Gains Tax Rate

Long-term capital gains, such as from company stock sales, currently have a top tax rate of 20% (plus the 3.8% Medicare surtax). Biden’s tax plan would raise the top rate on long-term capital gains and on qualified dividends to the highest rate of ordinary income tax for households with over $1 million in adjusted gross income ($500,000 for married filing separately).

The rate change would be retroactive to the date it was announced, considered to be April 28, 2021, when President Biden issued a Fact Sheet on the American Families Plan. The change for taxes for capital gains realized at death and with gifts, discussed below, would start January 1, 2022. (See pages 61–64 of the Green Book for more details on these capital gains proposals.)

Action Steps: With incentive stock options (ISOs) taxation, when you hold the shares more than two years from grant and one year from exercise, the full gain at sale over the exercise price is capital gain. While the tax treatment for NQSOs is fixed at exercise, for ISOs when you sell the stock without meeting the holding periods the tax treatment changes to essentially follow the ordinary income rates. Anyone with annual income of more than  $1 million will want to evaluate whether to risk holding ISO shares for the long-term capital gains rate when that rate would actually, under Biden’s plan, match their ordinary income rate.

Similar thinking applies to the decision with restricted stock about whether to make a Section 83(b) election to be taxed at grant instead of vesting. One big advantage of the election is to get an early start on the holding period for long-term capital gains. But under the proposed change, the tax rates on long-term and short-term capital gains for people in the top tax bracket may become the same anyway.

Details Murky On Proposed Change And Its Potential Impact

According to some experts, it remains unclear whether this higher capital gains rate would apply to all capital gains income or to only some portion of it (see Tax Reform In The American Families Plan from the law firm Morgan Lewis). Among the many other issues are how this change would impact the 0% rate on qualified small business stock (QSBS). The potential impact for individuals with stock by this proposed change, including the range of open issues and when to recognize capital gains income, is addressed by articles from Tech Crunch (Startup Employees Should Pay Attention To Biden’s Capital Gains Tax Plans), McDermott Will & Emery (What a Capital Gains Rate Hike Could Mean), and Morningstar (Capital Gains Tax Proposal a Wake-Up Call to Assess Concentrated Holdings).

The law firm Proskauer Rose predicts that if the capital gains rate increases, affected taxpayers will “defer sales of appreciated property and to use cashless collars and prepaid forward contracts to reduce economic exposure, and to monetize, liquid appreciated positions” (see Treasury’s Green Book Provides Details on the Biden Administration’s Tax Plan).

3. Capital Gains Realized Upon Death Or At Gifting Of Stock

Biden’s tax plan would dramatically change the capital gains treatment via gifting or upon death for transfers of appreciated property, such as company stock. For example, the ability to eliminate capital gains at death by a step-up in the basis on the shares, which allows heirs to then pay tax only on the appreciation after death, would no longer apply to gains over $1 million per person ($2 million per couple).

Alert: This does not mean that the basis for the remaining stock over these amounts is just carried forward to the person(s) inheriting it or the beneficiary, as has been misreported in some sources. Death itself triggers the recognition of capital gains tax on these amounts as if the stock was sold!

Similarly, any gifts made over these amounts would be taxable at that time to the gifter. Currently the receiver just carries forward the basis, and the giver would owe gift tax only if they did not have any of their lifetime gift/estate exemption amount remaining. Exceptions would apply, such as with transfers to a spouse, a charity, or heirs of small businesses and farms that continue to run those businesses. Donations of highly appreciated stock to charities would still avoid the capital gains tax, making it an even more popular strategy.

The Biden administration’s proposals so far do not yet include lowering the estate tax exemption from the current $11.7 million per person ($23.4 million for married couples), which was discussed during the campaign and may be forthcoming. However, that amount does automatically go down to $5.49 million per person (adjusted for inflation) at the start of 2026, when the provision sunsets at the end of 2025 under the Tax Cuts & Jobs Act (TCJA).

4. Beefed-Up Enforcement

The proposed legislation provides funding to “revitalize enforcement to make the wealthy pay what they owe” in an effort to shrink the tax gap, according to the Fact Sheet on the American Families Plan. This means with certainty an increase in audits of companies, executives, and others who are wealthy because of their stock compensation or founders’ stock. The audit rates on those making over $1 million per year, which fell by 80% between 2011 and 2018, will increase substantially. Financial institutions would be required to report information on account flows so that earnings from investments, such as from stock compensation and company stock holdings, are subject to broader IRS reporting.

Likelihood Of Tax-Law Changes

Whether any of these proposals will get adopted in their current form, and with the proposed effective dates, remains uncertain. Doubts about what will happen are raised by experts quoted in articles from Investment News (Political Reality Seen Curbing Biden’s Tax Plan) and Politico (Tax The Rich? Executives Predict Biden’s Big Plans Will Flop). The lobbyist and business group leaders quoted in the Politico article seem confident that they will pressure moderate Democrats in the House and Senate to “kill almost all of these tax hikes.”

A reminder of what tax ideas have not yet been proposed by Biden, such as taxing stock options at vesting, appears in a commentary from the law firm Brownstein Hyatt Farber Schreck (Will Biden’s American Families Plan Take Aim At Executive Compensation?). That proposal had been part of the initial draft of the TCJA, the tax-reform law enacted at the end of 2017.

myStockOptions Webinar Channel

See the myStockOptions webinar channel to register for our upcoming webinars and purchase our past webinars on demand in streaming format. On-demand webinars include:

Restricted Stock & RSU Financial Planning: Advanced Bootcamp (100 mins). This lively webinar features insights from a panel of three leading financial advisors, including case studies, to provide practical info, guidance, and expertise for restricted stock/RSUs in both public and private companies. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Stock Option Exercise Strategies: Advanced Bootcamp (100 mins). Stock options can offer great leverage, but it must be wielded wisely. It is crucial to have a strategic plan for stock option exercises. This webinar features compelling insights from a panel of three experts in option exercise strategies. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Stock Compensation Bootcamp For Financial Advisors (100 mins). Whether you are new to stock comp or want to sharpen your knowledge, our bootcamp webinar provides practical information and insights to maximize success. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

Strategies For Concentrated Positions In Company Stock (100 mins). Wealth is won and lost through the management of concentrated company stock positions. In this webinar, experts at managing concentrated stock wealth explain the wide range of strategies and solutions available for preventing losses and meeting goals. 2.0 CE credits for CFP, CPWA, CIMA, and CEP.

So Your Company Granted You RSUs. Now What? 3 Planning Tips From Top Financial Advisors

Getting an RSU grant is a reason to celebrate. But now comes the tricky part: financial and tax planning.

Restricted stock and RSUs are awards of company shares subject to a vesting schedule, which can be based on length of time employed after the grant date and/or on meeting specified performance goals. Once the grant vests you own the shares outright, at least in a public company. You can hold, sell, donate, or gift the shares as you wish (though you always need to avoid insider trading by not selling when you know important nonpublic information about the company).

However, financial planning with restricted stock and RSUs can be deceptively complex for a type of equity award that is supposed to be foolproof. Plus, you have the taxes to understand. Key questions to include on your planning checklist:

• What documents have the important grant details?
• How will withholding be handled at vesting?
• Should you hold or sell the shares?
• If you sell, how many shares should you sell, and what should you do with the proceeds?

Below we present three key planning topics recommended by financial advisors (all CFP® professionals) who have extensive experience in working for clients with restricted stock, RSUs, stock options, and ESPPs. For more on these planning topics with RSUs in particular, see articles at myStockOptions.com written by two of these advisors (Sell Or Hold RSU Shares At Vesting? 3 Approaches To Consider and Financial Planning With Restricted Stock Units: 3 Key Questions). In addition, all three of the advisors were featured presenters in a popular recent myStockOptions webinar on these topics: Restricted Stock & RSU Financial Planning: Advanced Bootcamp, now available on demand.

1. Understand Your Grant And Its Documents

This point may seem obvious, but you’d be surprised. We hear from financial advisors whose clients tell them they have “stock options” but upon inspection of the plan documents it turns out they have another type of equity comp. So, first of all, confirm which type of equity grant you have: restricted stock or RSUs, separate from any stock options or an employee stock purchase plan.

While restricted stock and RSUs are conceptually similar and close siblings, they have important differences that can matter for your financial planning (see an FAQ on the website myStockOptions.com that outlines the differences).

You want to review your actual stock plan, the grant agreement itself, communications materials your company provided, and any third-party website where you can view your grant and some of the details (e.g. website of broker or transfer agent). Two core facts to know about your grant from this review:

• Vesting schedule: how many shares vest and on what dates?
• What are tax-withholding choices?

You have many other potential factors to understand. “Roughly how much will each vested amount be worth, pre- and after-tax?” asks Meg Bartelt of Flow Financial Planning (Bellingham, WA). As someone who works with clients at pre-IPO and newly public companies, she also considers the traits of RSU grants made by private companies. Is simply working at the company for a specified length of time after the grant enough for the shares to vest, or is there a second trigger involving a liquidity event (i.e. IPO or acquisition by a public company)?

Then you need to know the impacts of job events, life events, and M&A on each grant, points out Chloé Moore of Financial Staples (Atlanta, GA). “How do leave of absence, disability, death, etc. affect the vesting schedule?” is something she considers for each of her clients. Daniel Zajac of Zajac Group (Exton, PA) concurs, adding: “What if the client leaves near retirement or is seeking another job?”

2. Know The Tax Impact

Watch out for taxes, emphasize all of the financial planners. Taxation can be tricky with restricted stock and RSUs.

Section 83(b) Election For Restricted Stock

With restricted stock, the usual time of taxation is vesting. However, within 30 days of the grant date you can make what’s called a Section 83(b) election to be taxed on the value of the shares at grant instead of at vesting (election not available for RSUs). If you’re confident the stock price will significantly rise between grant and vesting, this election to pay taxes on the lower value at grant can be a good bet, and it starts your capital gains holding period early. However, figuring out whether that is a good bet is complex and risky.

Tax-Withholding Issues

Then you face the issue of under-withheld taxes. According to the IRS rules for supplemental wage income, such as income from the vesting of restricted stock or RSUs, your company must withhold tax at a flat rate of 22%. (The rate jumps to 37% for income amounts in excess of $1 million during the calendar year.)

Here’s where it gets complicated. The rate you pay in your income-tax bracket is likely to be higher than the tax-withholding amount for your grant—especially after your income spikes with the vesting of your shares. Most people with just-vested restricted stock or RSUs need to pay extra taxes to make up the shortfall, whether via quarterly estimated tax payments or their tax return for the year. Therefore, unless you have extra cash lying around for your tax bill, you need to plan how many shares you need to sell to cover the taxes.

Mistakes here can be very costly. “The worst-case scenario with RSUs, in my opinion, is that you lose money on them,” says Meg Bartelt. “And that’s a possibility if you do not sell enough RSUs immediately to pay your full tax bill.”

The concern? The stock price could suddenly fall. “The bottom line is that if the stock price drops enough after the initial withholding of 22% before you sell more shares to pay your taxes, then the shares you still have can be worth less than the taxes you still owe.”

“Get ahead of the game by preparing a projected tax return to see the impact of vesting RSUs on your tax return,” advises Daniel Zajac. “Consider ways to defer other income and/or increase deductions to reduce the spike in your taxable income,” he adds. “For example, increase 401(k) contributions, participate in a nonqualified deferred compensation plan, make bigger charitable donations, or separately increase salary withholding.”

3. Have A Strategic Plan For The Shares After Vesting

Chloé Moore of Financial Staples in Atlanta has helped many clients meet their financial goals with tailor-made strategies for RSU shares. In one example that she explained to us, her approach included:

• Allocated monthly savings, cash bonuses, and sign-on bonus to short-term savings goals.
• Kept 25% of shares that vested after the one-year anniversary (about 30% of the portfolio and a smaller percentage as the portfolio grew).
• Set aside reserves to pay the tax bill (worked with a CPA to estimate each year’s tax liability).
• Sold remaining shares as they vested and split the proceeds between student loans and savings goals, then eventually a diversified taxable account.

This is just one example of an approach when shares vest. Everyone’s individual circumstances differ. Identifying strategies that work for you is one good reason to consult a financial planner.

Concentration Risk: Don’t Keep All Your Eggs In One Basket

An important part of financial planning for just-vested shares is understanding the risks of holding them and the need for diversification. After the vesting, you could have substantial amounts of your personal wealth tied up in just one stock. We’ve all seen how quickly a stock price can tank. If you are, for example, subject to trading restrictions by your company during a blackout period, you may not be able to immediately sell shares to avert losses. With a falling stock price, all you could do in that case is watch the value plummet.

“Investments that are diversified—your money is invested a little bit in a lot of different stocks or bonds—perform better, on average, than investments that are concentrated in one stock,” points out Meg Bartelt. “Diversification is said to be ‘the only free lunch in investing.’ Keeping your company stock is anti-diversification.”

Meg often generally advises clients with just-vested RSU shares to sell all the stock. “Let’s say your RSUs are worth $100,000 when they vest. If I gave you $100,000 in cash income instead, would you go out and use that money to buy your company stock? If your answer is no, then that is literally the same, financially, as selling all your RSU shares.”

In her view, “you’re better off selling them all and using the money immediately for some current need (such as a down payment on a house) or other financial opportunity (such as paying off debt), or investing the money in a broadly diversified, low-cost portfolio.”

This is just one type of strategy. “There’s an almost infinite spectrum of decisions you could make here,” observes Meg. Holding some shares can often be more acceptable to clients, she explains.

The most important point, in her view, is diversifying and thus reducing the risks that arise from concentration of wealth in just one vulnerable stock. “Selling at least some shares is progress toward a portfolio whose risk-adjusted return is optimized.”

More Strategies To Reduce Concentration Risk

“One strategy that may balance the decision to immediately retain 100% of the shares or sell 100% is to implement a plan that sells a certain number or percentage of shares over a set period,” says Daniel Zajac.

“Setting a sell schedule allows you to intentionally reduce your company stock according to a formula,” he explains. “That removes some of the emotional decision-making from the process. You don’t need to guess what the stock price will do next, or decide you will sell when the price reaches X per share, but change your plans once the price does hit that point. You then risk the price going back down before you do sell.”

For clients who are loyal to their company stock and feel reluctant to “dump” it, a compromise approach can be highly beneficial, Meg suggests. “I find this cognitive flexibility comes in handy when I’m working with clients whose net worth is tied up heavily in their company stock. In my profession, there’s a rule of thumb that no more than 5% of your investment portfolio should be in a single stock. Often I work with clients who have 20%, 50%, 90% of their liquid net worth (i.e. cash and investment accounts) in their company stock.”

For many people in this position, selling all the way down to 5% is often “just too big a shock to the system,” Meg has learned. “But I find most people are fine going from 90% to 70%. Or 50% to 40%. And you know what? That’s progress.”

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WEBINAR: Stock Option Exercise Strategies: Advanced Bootcamp

• June 24, 2pm–3:40pm ET, 11am–12:40pm PT
• 2.0 CE credits for CFP, CIMA, CPWA, and CEP

Employees with stock option grants, whether NQSOs or ISOs, face important wealth-building and tax-minimizing decisions about when to exercise their stock options. Our upcoming webinar Stock Option Exercise Strategies: Advanced Bootcamp will clearly explain the variety of stock option exercise strategies to both build wealth and prevent expensive mistakes. This webinar is part of our advanced series building on our flagship webinar Stock Compensation Bootcamp For Financial Advisors.

Registration is now open for this lively educational event. In 100 minutes, it will feature insights from a panel of three leading financial advisors, including real-world case studies, to provide practical info, guidance, and expertise for stock options in both public and private companies.

For a detailed agenda of topics covered, see the webinar registration page.

Time conflict? No problem. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the presentation slide deck. Therefore, even if you have a time conflict, please still register, as you will receive a link to the recording and presentation.

Tax Day 2021: 8 Key Things To Know About Tax-Return Extensions

Tax Day 2021 is May 17 (Monday). If you haven't yet filed your federal tax return, you need to decide whether to go for it now or get an extension.

Many situations can lead you to file an extension. For example, stock compensation income—e.g. from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock—can raise your income tax and make your return complex. You may just need a little extra time, especially with everything else going in the world right now. The good news is that, if you can't file by May 17, you can get an extension of your filing due date without any questions asked.

However, you must understand the rules. To avoid getting hit with IRS penalties, particularly if you don’t have the money to pay taxes owed with your 2020 Form 1040 tax return, below are 8 crucial things to know about filing an extension.

1. Extension Does Not Need IRS Approval

To gain an automatic extension for the due date of your tax return (to October 15), you can use IRS Form 4868, Application For Automatic Extension Of Time To File. Alternatively, you can file for an extension through the IRS Free File system.

The IRS automatically processes a tax-return filing extension if you pay all or part of your taxes electronically by the deadline. You don't need to file a paper or electronic Form 4868 when making a payment with IRS Direct Pay, the Electronic Federal Tax Payment System, or with a debit or credit card. Simply select "extension" as the reason for the payment.

2. Extension Does Not Delay Taxes Owed Or IRA Deadline

The extension to October 15 applies only to the filing of your tax return. It does not delay any tax you may owe beyond what you already paid the IRS in withholding and/or estimated taxes. To avoid penalties, be sure to pay taxes you expect to owe by the May 17 IRS filing deadline. Note that the extension also does not delay the deadline for making 2020 contributions to IRAs and HSAs beyond May 17.

3.  File Your Tax Return Even If You Cannot Pay Taxes Owed

If you are ready to file, you may want to file your tax returns on May 17 even if you cannot pay taxes due right now. To avoid a late-filing penalty, file your return on time and pay as much as you can. The IRS will then send you a bill or notice for the remaining amount you owe, including any penalties and interest. If you can’t pay that now, see #4 below.

4.  You Can Work Out A Deal With The IRS

If you lack the money to pay your income tax, consider asking to pay by installments or working out with the IRS an online payment agreement, an offer in compromise, or a temporary delay in collection until your financial situation improves.

“It is an extension to file and NOT an extension to pay,” notes Beth Logan, EA, who works with Kozlog Tax Advisers and is a past president of the Massachusetts Society of Enrolled Agents. “If you’re filing an extension to avoid your tax bill, you are only hurting yourself.”

Logan recommends that you send the return and then contact the IRS or get a tax return professional (an Enrolled Agent and/or CPA) to contact the IRS for one of these payment methods. Many states, she explains, also offer a delay in paying for hardships, such as unemployment. A delay doesn’t make the taxes go away, but at least the tax authorities will leave you alone for a while (up to two years in Massachusetts).

“For most people, the interest rate on their credit cards far exceeds the interest rate charged by the IRS or the states,” Logan warns. “Therefore, you are usually better off on a payment plan than using a credit card for unpaid taxes.”

5. IRS Has Different Penalties For Failure To File And Failure To Pay

As outlined on its website, IRS has different penalties for failure to file your tax return and for nonpayment or underpayment of taxes owed. To avoid an underpayment penalty, when you file a tax-return extension you need to have paid at least 90% of the total actual income tax for the year of the return. This means that if you end up paying more than 10% of your total tax owed with your actual return after the deadline, interest and penalties will apply.

The penalty for failing to file is generally more costly than the penalty for failing to pay, explains Susan Allen of the AICPA. The penalty for missing the initial filing due date or the extended deadline is 5% of the balance due for each month, or part of a month, up to a maximum of 25%. The IRS does not assess penalties for both failure to file and failure to pay for the same period, she says.

6. Remember To File An Extension For Your State Tax Return

Don't forget about your state tax return. Most states also shifted their tax-return deadlines to May 17. For example, if you pay tax to the state of California and cannot file by the due date, you get a filing extension. As with your federal return, you will still need to pay a specified percentage (e.g. 90%) of any tax you owe by the filing deadline.

7. Extension Does Not Increase Risk Of IRS Audit

This is a myth, as explained in a quiz on tax-return extensions at the AICPA website: “The IRS’s audit selection process is based on what is included (or not included) on the return, not when it’s filed.”

“A rushed-through return is more likely to contain mistakes,” warns the AICPA. “An error-riddled return—or one that’s intentionally missing information—is far more of a red flag [for the IRS] than a carefully prepared and reviewed return that’s filed by the extended due date.”

8. Looking Ahead: Estimated Tax Payments

If you make estimated tax payments, such as for an income spike from stock compensation, the payment for the first quarter of 2021 was still due at the usual time on April 15 (see our blog commentary on this oddity). To avoid any penalties on your tax return next year, be sure you pay the IRS in 2021 either 90% of your expected tax bill or 100% of last year's taxes.

In a typical year, when the due dates for tax returns and the first estimated tax payment are the same, if you file an extension of your tax return on IRS Form 4868 one approach is to overpay the IRS the amount of additional taxes you expect to owe when you file your return. You overpay by what you approximately calculate will be needed for the first estimated tax payment due on April 15. Then you have the amount of the refund go to the first quarter's estimated tax payment.

Paying the first quarter's estimated tax indirectly through the extension could provide some extra funds should the final tax amount due with the actual return be larger. This is an approach followed in the past by Jonathan Gassman, a CPA with the Gassman Financial Group in New York, whom we spoke with while researching this article.

However, in this unusual year, with a month-long difference between the due dates, the IRS issued additional guidance clarifying that the extension filing with the overpayment needed to occur by April 15 to get it credited to the first quarter estimated tax payment. The IRS repeatedly stated, with examples, that "an extension of time to file has no effect on either the date of payment or the date on which an overpayment exists."

For guidance about tax returns and estimated taxes on stock options, restricted stock/RSUs, ESPPs, and SARs, see the Tax Center at myStockOptions.com.

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SAVE THE DATES: Upcoming myStockOptions Webinars In May And June 2021

Improve your stock comp knowledge and get CE credit hours in our upcoming webinars. Registration is now open for all of these:

Strategies For Concentrated Positions In Company Stock
May 26, 2pm–3:40pm ET, 11am–12:40pm PT
Wealth is won and lost through the management of concentrated company stock positions. With the S&P 500 setting record highs, financial advisors need to understand the wide range of strategies and solutions available for preventing loss of wealth and for meeting clients' financial goals. Join us on May 26 (2pm–3:40pm ET, 11am–12:40pm PT) for our webinar on managing concentrated positions in company stock. In 100 lively minutes, experts at managing concentrated stock wealth will explain the approaches. Register now.

Restricted Stock & RSU Financial Planning: Advanced Bootcamp
June 10, 2pm–3:40pm ET, 11am–12:40pm PT
Restricted stock and restricted stock units (RSUs) have become the most common type of equity compensation. This webinar focuses on financial and tax planning for restricted stock/RSUs to serve clients effectively, build wealth, and prevent expensive mistakes. Join us on June 10 (2pm–3:40pm ET, 11am–12:40pm PT) for this lively educational event. In 100 minutes, it features insights from a panel of three leading financial advisors, including real-world case studies, to provide practical info, guidance, and expertise for restricted stock/RSUs in both public and private companies. Register now.

Stock Option Exercise Strategies: Advanced Bootcamp
June 24, 2pm–3:40pm ET, 11am–12:40pm PT
Employees with stock option grants, whether NQSOs or ISOs, face important wealth-building and tax-minimizing decisions about when to exercise their stock options. This webinar focuses on stock option exercise strategies to serve clients effectively, build wealth, and prevent expensive mistakes. Join us on June 24 (2pm–3:40pm ET, 11am–12:40pm PT) for this lively educational event. In 100 minutes, it features insights from a panel of three leading financial advisors, including real-world case studies, to provide practical info, guidance, and expertise for stock options in both public and private companies. Register now.

Estimated Taxes And Stock Comp: Special Issues In 2021

When the IRS extended the tax return deadline to May 17, it kept the usual April 15 due date for the first quarterly estimated tax payment of 2021. This was awkward for the many people planning to base 2021 estimated taxes on 2020 income reported in their Form 1040 tax returns. How are you supposed to know your April estimated tax payment if you haven't yet done your 2020 tax return?

The standard flat 22% federal rate used for tax withholding on stock compensation is usually too low for most employees and executives getting these grants. Paying quarterly estimated taxes is one way to avoid an IRS penalty for tax underpayment. Most people who pay estimated taxes base their payments on the income reported on their tax return to fit into the 100% or 110% safe harbors. Some taxpayers simply finished their returns by April 15 and sent their estimated payments. Others are waiting to act on the first 2021 estimated tax payment until they finish their tax returns.

If you need to pay 2021 estimated taxes and are waiting to finish your 2020 tax return before you make your April payment, this blog commentary explains the issues involved, including insights from tax pros on this unusual situation.

Why 2020 Tax Returns Impact 2021 Estimated Taxes

According to the IRS Data Book, over 22.2 million individual estimated tax forms (Form 1040–ES) were filed in fiscal year 2019. This population of taxpayers includes self-employed people, gig-economy workers, small-business owners, retirees, and investors—a broad cross-section of people with widely varying income levels and occupations, not just the wealthy.

Federal tax law requires all of us to pay at least 90% of our income tax liability through either withholding and/or quarterly estimated tax payments. For those whose income is not subject to withholding, or if you’re a W-2 employee who does not pay enough in taxes during the year via payroll withholding, you pay quarterly estimated taxes on April 15, June 15, September 15, and January 15 of the following year (dates may vary slightly for weekends or holidays).

Underpayment of taxes subjects you to an IRS penalty. You avoid that penalty through one of three safe harbors:

• You owe less than $1,000 in tax for the year.
• You pay at least 90% of tax owed for the current year (2021), or 100% of the tax you paid for the prior year (2020), whichever is smaller.
• For adjusted gross income greater than $150,000 ($75,000 married filing separately) on the prior year's tax return, the percentage of last year’s tax (2020) that you must cover during this year is higher: the safe harbor is 110%.

For more details on estimated taxes with stock compensation, see myStockOptions FAQs on NQSOs, ISOs, SARs, restricted stock, and ESPPs. If you don’t pay enough taxes, IRS Form 2210 helps you calculate any penalty for underpayment of estimated tax. States that have income tax also have their own estimated tax requirements and safe harbors.

Some Taxpayers Met April 15 Due Date

To avoid the issue, some people filed their tax returns and first-quarter (Q1) estimated taxes on April 15. Others merely paid estimated taxes on April 15, with an informed guess as to what is owed, while waiting to file their tax returns.

Randy Joseph, a CPA with Joseph & Hetrick in Seattle, has many clients with equity compensation, such as employee stock options and restricted stock units. She explained that they pay estimated tax either quarterly or with each vesting to make up for the withholding shortfall. With two separate dates, "our concern has been client confusion over what to do on what date," she told us.

"No one has balked at making that first estimate by April 15," she continued. "My only balk came from a tech-company client who didn’t want to have to sell his company stock to pay 2020 taxes now and wanted to wait until May 17 because his company stock was rising. But he is one out of hundreds."

J.T. Harold Forbus, Senior Tax Manager with Bogdan & Frasco in San Francisco, explained that for clients who have substantial Q1 estimates the firm suggested they pay by April 15, particularly when the firm knew the Q1 estimates (e.g. based on stock option exercises) would be very large.

What To Do About Outstanding Q1 Estimated Tax

Some taxpayers chose to ignore the April 15 estimated tax due date and instead pay estimated taxes when the tax return is filed in May. The justification for this approach is that the penalty for paying estimated taxes late is so small that it’s not worth the extra effort, or additional expense from a tax return professional, to do it separately from the tax return.

Jan F. Lewis, CPA and Tax Partner with Haddox Reid Eubank Betts in Jackson, Mississippi, explained to me why this approach can make sense. “We have to be reasonable and we have to be upfront with our clients. The estimated tax penalty is really interest—charged at a 3% annual rate—that makes the monthly charge a quarter of 1%. That’s $25 on a $10,000 estimate per month. So if we don’t have the numbers yet, or don’t have the time to get an accurate number by April 15, that’s a pretty low cost if the client needs to wait until May 17, when the picture may be clearer.”

Elliott Puretz, a CPA and retired college accounting professor in the Boston area, bluntly wrote to his clients that "I am not determining the amounts for the 2021 estimated tax payment No. 1 until the tax return for 2020 is completed. It would cost you more for me to do that (separate from the tax return) than the minuscule penalty the IRS might (unlikely in my opinion) charge for the payment being a month late (less than one half of one percent of the payment)."

IRS Guidance On Overpaying With A Tax-Return Extension

With an extension of your tax-return filing deadline on IRS Form 4868, you pay the IRS the amount of additional taxes you expect to owe for tax year 2020 when you file your return. You can overpay that amount by what you approximately calculate is needed for the first estimated tax payment due April 15. Then have the amount of the refund go to the first quarter estimated tax payment.

Jonathan Gassman, a CPA with the Gassman Financial Group in New York, explained that while his firm is working as if the April 15 deadline applies for the clients who normally make an estimated tax payment, this is the approach he takes with any extension. In addition, paying the first quarter estimated tax payment indirectly through the extension can provide some extra funds should the final tax amount due with the actual return be larger, he noted.

The AICPA, the world's largest member association representing the accounting profession, cautioned before the April 15 due date that "we are not certain that a payment with a Form 4868, even if paid by April 15, will be credited by the IRS as paid by April 15."

The IRS eventually issued additional guidance clarifying that the extension filing with the overpayment needs to occur by April 15 to get it credited to the first quarter estimated tax payment. The IRS repeatedly said in it and with examples that "An extension of time to file has no effect on either the date of payment or the date on which an overpayment exists."

Under this IRS guidance, the same logic would apply to a tax return punctually filed by May 15 that directs any 2020 overpayment to pay 2021 estimated taxes (see Form 1040 line 36).

Why The IRS Did Not Want To Move Estimated Tax Due Date

In spite of widespread pressure from tax professionals to have the dates match, including from CPAs and enrolled agents (EAs), the IRS refused. This caused an uproar in the tax profession and has even led to congressional legislation attempting to shift the date.

The IRS remained adamant in not moving the April date. To explain why, IRS Commissioner Charles Rettig made the following statement in a recent congressional hearing: "There’s a large contingent of wealthy individuals in this country who do not make their estimated payments and who essentially take the money they should be paying in quarterly estimated payments to the government and take the arbitrage, invest it, and we’re not going to give them a break of interest and penalties to do so."

He also said that "this issue is, where do we draw a line, and that line will quickly run to wealthy individuals who game the system." You can hear these statements in the video, around 1:13 and 1:42.

Phyllis Jo Kubey, EA, the president of the NY State Society of Enrolled Agents, told me her view of these statements, a sentiment echoed by every tax-return professional I contacted. "I was horrified to hear Commissioner Rettig’s remarks about not wanting to create an arbitrage opportunity for wealthy taxpayers. Most of my clients who pay estimated taxes are musicians, clergy, and senior citizens—and most have adjusted gross incomes (AGIs) well below $100K." Additionally, she said, the administrative complexity of keeping the estimated tax due date April 15 when the returns are due May 17 is "huge for taxpayers, tax professionals, and (I suspect) for the IRS."

For guidance on tax returns and estimated taxes on stock compensation (stock options, restricted stock/RSUs, ESPPs, and SARs), see the Tax Center at myStockOptions.com.

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Webinar: Stock Compensation Bootcamp for Financial Advisors

Equity compensation is booming. Improve your stock comp fitness in this webinar on the essentials of stock options, restricted stock/RSUs, and ESPPs.

Register now for this lively educational event on April 29 (2pm–3:40pm ET, 11am–12:40pm PT), offering 2.0 CE credits for CFPs and CEPs.

In just 100 lively minutes, learn what you need to know to serve clients better, build wealth, and prevent mistakes. Whether you are new to equity comp or want to sharpen your knowledge, the practical info and insights will help maximize your success.

Time conflict? No problem! All webinar registrants get access to the recording and the presentation slide deck.

The Top 3 Tax Numbers You Need To Know In 2021

This January has been a doozy for us all. However, amid your busy work and personal life, Covid, the new presidential administration, and the upcoming tax-return season, don’t forget basic tax planning for 2021.

At the start of each year, key numbers in many tax-law provisions are adjusted for inflation. Many of the adjustments are important for employees, their paychecks, and their basic tax planning for 2021. While the IRS and Social Security Administration announce these figures every fall, January is really when you need to pay attention to them.

Many tax-code sections are adjusted, and it can be hard to spot those that matter to you. Some are of interest only to super-wealthy executives and other individuals, such as the federal exemption for estate tax (in 2021, $11.7 million for single taxpayers and $23.4 million for married joint filers). Others are chiefly matters for corporate benefit-plan administrators. For example, the income definition of “highly compensated employee,” which affects eligibility for employee stock purchase plans (ESPPs) and 401(k) plan non-discrimination testing, is $130,000 in 2021.

Below are the top three sets of tax figures that all employees should know. They relate to compensation from work: paycheck withholding, the potential need for estimated taxes, and your retirement savings. You can find in-depth content on all of these tax topics in the Tax Center at myStockOptions.com.

1. The Social Security Wage Base

Social Security tax (6.2%) applies to wages up to a maximum amount per year set annually by the Social Security Administration. Income above that threshold is not subject to Social Security tax (by contrast, Medicare tax is uncapped, with a rate of either 1.45% or 2.35%, depending on your income level).

In 2021, the Social Security wage cap is $142,800, up slightly from $137,700 in 2020. This means the maximum possible Social Security withholding in 2021 is $8,853.60. Once your income is over that amount, you’ll see 6.2% more in your paycheck!

2. Your Income-Tax Bracket And Withholding

The table below can help you understand how an additional amount of compensation would be taxed at your marginal tax rate (i.e. the percent of tax you pay for an additional dollar of income in your current tax bracket). This number tells you whether the taxes withheld according to your information on the revised Form W-4 will cover the total tax you will owe for 2021. To avoid “penalizing” additional income in your mind, be sure you know your effective or average tax rate.

Need To Pay Estimated Taxes?

Additional compensation received, such as a cash bonus or income from a nonqualified stock option exercise or vesting of restricted stock units, is considered supplemental wage income. For federal income-tax withholding, most companies do not use your W-4 rate. Instead, they apply the IRS flat rate of 22% for supplemental income (the rate is 37% for yearly supplemental income in excess of $1 million).

As shown by the table above, once you know your marginal tax-bracket rate, you may find the withholding rate of 22% may not cover all of the taxes that you will owe on supplemental wage income. In that case, you must either put extra money aside for the 2021 tax return you will file in 2022, pay estimated taxes during 2021, or adjust your W-4 for your salary withholding as soon as possible to cover the shortfall.

3. Your Contribution Limit For Qualified Retirement Plans

In 2021, you can elect to defer up to $19,500 from your paychecks into qualified retirement plans, such as your 401(k). The total ceiling for deferrals to defined contribution retirement plans, including any extra part contributed by your employer, rose to $58,000 in 2021, a $1,000 increase over last year’s amount. Both of these limits are $6,500 higher if you are 50 or older.

The amount of compensation income that can be considered in the calculation for qualified deferrals rose to $290,000 in 2021. Check with your company’s 401(k) plan administrator for the process of making changes in your compensation deferral election.

Want To Defer More Income?

Look into whether your company has a nonqualified deferred compensation plan, sometimes called an excess 401(k) plan or other name. For more on these plans, see our sibling website myNQDC.com.

IRS Resources

Here are resources with more details on the many adjusted 2021 tax numbers:

• Revenue Procedure 2020-45 gives inflation adjustments in various income-tax-related provisions.
• IRS Notice 2020-79 and an IRS table give the annual adjustments related to various tax-qualified retirement plans.

Webinar: Stock Compensation Bootcamp for Financial Advisors

Our latest webinar, Stock Compensation Bootcamp For Financial Advisors, is available to stream on demand. Learn what you need to know about stock options, restricted stock, RSUs, and ESPPs to best serve clients, build wealth, and prevent costly mistakes. Whether you are new to stock comp or want to sharpen your knowledge, this webinar provides practical information and insights to maximize your success.

See the webinar page for details and an agenda of topics covered.

Year-End Donations Of Stock: 7 Ways To Make The Most Of Your Charitable Giving & Tax Deduction

Despite the worsening pandemic and widespread economic uncertainty, the stock market is hitting new highs. For the financially fortunate among us, there has never been a better time to support the less fortunate.

Donating stock instead of cash to charities and other nonprofit organizations can not only provide crucial assistance for them but also boost the tax deduction you receive for your generosity. This is true whether you have greatly appreciated shares acquired long ago in one of the most valuable stocks of 2020 (e.g. Amazon, Apple, Etsy, FedEx); stock from being an early-stage investor in an upcoming hot IPO company (Airbnb, DoorDash); or company shares acquired from the exercise of stock options, the vesting of restricted stock/RSUs, or an employee stock purchase plan.

1. Core Tax Rules For Stock Donations

After you have held stock for more than one year and its price has risen, at the time of the donation you get a tax deduction equal to the fair market value of the stock (i.e. not your lower purchase price, technically known as the cost basis). For stock not held for one year, the deduction is the cost basis or the current fair market value, whichever is lower.

If the sale of the appreciated shares would have triggered long-term capital gains, your deduction is up to 30% of your adjusted gross income (20% for family foundations), and you can carry forward higher amounts for five years. When the sale of the shares would have produced ordinary income or short-term capital gain, the deduction is limited to 50% of your adjusted gross income (30% for family foundations) with five-year carry-forwards. Shares gifted to donor-advised funds receive the same tax treatment.

2. How Stock Donations Are Valued For Tax Deductions

For public companies with an active market in their stock, the fair market value for the donation is the average between the high and the low stock selling prices on the delivery date. For the stock of pre-IPO companies, you need a valuation by appraisal or some other reasonable valuation method. You, with your tax and financial advisors, want to review various sources, including IRS Revenue Ruling 59-60. It lists valuation factors and explains that no general formula fits all private-company situations.

3. Donation With Stock Can Be Bigger Than With Cash

With a charitable gift of appreciated securities held long-term, the donation you make and the deduction you get are greater than they would be if you were to sell the shares and donate the cash proceeds instead. That is because when you donate shares, you avoid paying the capital gains tax.

Donation Example

Suppose you can either (1) donate $50,000 in stock held more than one year or (2) sell the stock first and donate the proceeds. The stock has a cost basis of $10,000. You have a 40% combined federal and state tax rate on your income and a combined 20% tax rate on capital gains.

4. Company Stock Can Help Bunch Donations

The advice from many experts is to bunch donations so that your itemized deductions go beyond the Tax Cuts & Jobs Act standard deduction amounts in 2020 of $12,400 for individuals and $24,800 for joint filers (adjusted annually for inflation). If you do not routinely exceed the standard deduction, you can get over it by bunching in a given year donations of stock to charities or a donor-advised fund.

Alert: The CARES Act, adopted in response to the Covid-19 pandemic and related economic crisis, does have provisions on charitable contributions, but they do not involve stock donations. Taxpayers who use the standard deductions instead of itemizing deductions can claim up to a $300 deduction for a cash donation to a charity directly off adjusted gross income (i.e. an “above the line” deduction on Line 10b of the IRS draft 2020 Form 1040). For the 2020 tax year, the legislation also increases the deduction percentage limitation for cash charitable contributions (not stock) from 60% to 100% of adjusted gross income.

5. Extra Time May Be Needed To Process Stock Donations

To obtain a deduction for the current tax year, the stock transfer must be completed by December 31. For electronic transfers from your brokerage account, the donation is recorded on the day it is received (not when you approve the transfer). Plan your year-end stock gifts as early as possible, know the process the charity or nonprofit requires, and have ongoing communications with your broker to ensure that the transfer takes place.

If you have valuable stock in a pre-IPO company, you will want to start the process especially early. Donations and transfers of stock in a private company can take longer than those for stock in public companies and can raise valuation issues.

Donating appreciated stock can be easier through tools like Cocatalyst. Developed with financial advisors, donors, and charities in mind, Cocatalyst has each donor fill out a secure webform and then automatically processes the stock donation with their brokerage firm. Charities of all sizes can use the Cocatalyst system to process their stock donations from donors and receive ACH or check transfers. The company explained to me that the tool is similar to a pass-through donor advised fund (DAF), but focused on directly donating stock, which offers more tax flexibility while retaining the benefits of a DAF.

Alex Chung is the founder of Cocatalyst and a current member of its board. “We wanted to enable every donor to be able to give in a tax effective way without the headache,” he told us in response to our request for comment. “Maximizing donations through stock donations and other tax strategies is important because it helps charities get every last dollar.”

Alex started Cocatalyst because he wanted to streamline his family office's philanthropic giving, but he ultimately decided to make the tool available to all. According to Cocatalyst Research, there are over $21 billion in stock donations per year, and that figure is growing at 62% annually. He pointed out to us that philanthropists such as Jack Dorsey (Twitter) and Phil Knight (Nike) have made large contributions using stock in the past year.

6. Must File Special IRS Form

With your tax return, you need to report the stock donation on IRS Form 8283, used for your noncash charitable contribution. The instructions for the form and IRS Publication 561 explain the rules that apply when you must obtain and include a written appraisal. For example, with private-company stock valued at $10,000 or less, a qualified appraisal is not needed (it is for higher amounts), but the charity needs to explain how it determined the valuation. For a donation of publicly traded stock, you do not need an appraisal.

7. Special Issues With Stock Compensation

For a charitable donation of company stock acquired from equity compensation, the tax treatment and rules are the same as they are for donations of any stock to a qualified charity or donor-advised fund. If the donated shares were acquired from incentive stock options (ISOs) or an employee stock purchase plan (ESPP), be sure you donate the shares after you have met the related special holding periods for ISO and ESPP stock (more than two years from grant and one year from exercise/purchase). Executives and directors will also want to review the Section 16 and Rule 144 requirements before gifting or donating company stock.

More Ideas For Financial Planning With Stock

For other ideas on year-end financial and tax planning for company shares, see the year-end articles and FAQs at myStockOptions. The website’s section on gifts and donations has additional related content, such as on charitable remainder trusts, private foundations, and estate planning.

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Post-Election Year-End Planning: What Financial Advisors & Tax Pros Are Advising Clients About Uncertain Tax Changes

The end of the year is a key time for financial and tax planning. The standard year-end-planning strategy is to defer income into the next year and accelerate deductions into the current year. But tax planning for year-end 2020 could change now that Joe Biden has won the presidency and Democrats may gain complete control of Congress. Biden's tax plan calls for tax increases on high earners.

However, the outlook for tax increases under President Biden is very uncertain. It depends largely on which party holds the majority of the US Senate, which will not be determined until the special runoff election for both of Georgia's US Senate spots in early January, after the end of the year-end-planning season. Even if Democrats do win Senate control to go along with their majority in the House of Representatives, many experts say tax-law changes are unlikely to be a focus of Biden’s first year. In addition, you never want taxes to be the sole reason for making decisions with your equity comp and company shares. Nevertheless, some financial advisors and estate planners are still expecting higher taxes at some point under the Biden administration. What does all of this mean for year-end planning in 2020?

The Biden Tax Changes That Could Alter Year-End Planning

Among the different parts of Biden’s tax plan, these three would have an immediate impact on 2020 year-end planning:

1. The top rate of ordinary income tax would return to 39.6% from 37% for taxpayers with income over $400,000. What remains unclear is whether this income level would be different for couples (married filing jointly) and whether it’s $400,000 in adjusted gross income (i.e. before deductions) or in taxable income. If this tax hike seems likely to you in 2021 and you're concerned about higher tax rates, it would lead to accelerating income into 2020 where possible (e.g. exercise nonqualified stock options, receive cash bonuses before year end, do Roth IRA conversions).

2. Biden’s tax plan would raise the top rate of capital gains tax from 20% to 39.6% for individuals with over $1 million in yearly income. Capital gains and qualified dividends currently have a top tax rate of 20% (plus the 3.8% Medicare surtax). If this major increase in the top capital gains rate seemed likely to take effect in 2021, it could lead to capital gains harvesting before year-end to sell shares with substantial appreciation, paying tax at the lower capital gains rate, then potentially repurchasing the shares to reset the basis in them (see the FAQ on myStockOptions about this strategy).

Alert: Whenever you sell company stock, you must be careful not to commit insider trading, which is illegal. To prevent insider trading, your company may have blackout periods when you can't trade, often around the end of each calendar quarter, and window periods when you can. As part of any strategy involving stock sales, you need to know when these periods occur.

3. Biden’s tax plan would limit itemized deductions to 28% of value, with some deductions phasing out for income over $400,000. That would lead to also accelerating deductions, such as donations, into the current year for high-income taxpayers (the reverse of the usual approach when you expect higher taxes in the future) to maximize them before limits put into place. This concept is explained by financial advisor Jeffrey Levine in the Kitces.com blog.

Tax Changes Not Expected In 2021

In my review of client alerts and updates from wealth management, tax, and financial advisory firms of various sizes, I found they see little chance of taxes increasing in 2021:

• Northern Trust:  “We expect an agreement on some fiscal stimulus, while tax increases are off the table.... [T]he most likely outcome is divided government that will significantly limit policy.”
• PwC: “A Republican-controlled Senate would largely eliminate the prospect of any significant tax increases until at least after the 2022 midterm elections. If Democrats do win an operational Senate majority with the tie-breaking vote of a Vice President Harris, the outlook for action on Biden’s tax plans could be put into question because of the challenges of operating in an evenly divided Senate.”
• Grant Thornton: “While it is always possible that Democrats win both runoffs in Georgia and immediately pursue tax increases with Senate control, it would be surprising. Key Democrats have already indicated their first priority will be legislation battling COVID-19 and offering economic relief, and have signaled a reluctance to raise taxes while the economy is fragile. Taxpayers should exercise serious caution before using planning strategies that would accelerate income in anticipation of tax increases that appear increasingly unlikely to happen immediately.”
• Manning & Napier (Fairport, NY): “Significant changes to tax policy are always difficult to pass, even in times of united, one-party control. Given current projections for a divided federal government, we believe the odds of tax reform have become even less likely. In our view, it is difficult to see how the varied political interests in Washington DC would be able to come together on a topic this controversial.”

Mark Mazur, the director of the Urban-Brookings Tax Policy Center and a former assistant secretary for tax policy at the US Treasury, predicts in an article at the website Law360 that President Biden will “punt” negotiations on Tax Cuts & Jobs Act provisions that expire at the end of 2025 into the next Congress. He thinks that Biden will instead focus on other priorities in his campaign platform. "There's no need to decide in 2021 what the tax code of 2026 will look like," Mazur told Law360.

Analysts from the Urban Institute recently updated their analysis of the Biden tax proposals. They do not foresee an effective date for new tax provisions any earlier than January 1, 2022.

The possible reasons for this delay are explained by John P. Barringer, Managing Partner of Executive Wealth Planning Partners in Denver, Colorado, in his myStockOptions article Stockbrokers' Secrets: Year-End Planning For NQSOs, Restricted Stock, And RSUs. “Even if the Democrats eventually gain control of three branches of the federal government, tax changes are not likely to be the first thing on their agenda,” he writes. “Over the last two years, the Democratic majority in the House of Representatives has passed hundreds of bills to address climate change, racial inequality, police reform, and voting rights. That stack of bills would be the first thing the Senate would want to review if party power changed.... So, with everything a new administration and Congress will have on their to-do list, regardless of the eventual outcome in each chamber, tax changes are unlikely to be addressed until at least 2022.”

What Financial Advisors, Tax Pros, And Lawyers Are Recommending

In its article, Grant Thornton says you should “be very cautious about rushing transactions or asset sales in ways that forfeit value, especially as immediate tax increases now look much less likely. Income and tax acceleration strategies should also be balanced against liquidity needs during this period of economic disruption, and only after considering the time value of money.”

Given the very low interest rates on money saved in the bank that you could apply to paying taxes, an article by CPA and financial advisor Craig Richards of Fiduciary Trust Company International raises the question of whether “it may be worth taking the chance” to accelerate income into this year if you are concerned about higher future taxes.

Jonathan Gassman, a CPA and the CEO/founder of accounting and wealth management firm Gassman Financial Group (New York), emphasized to me that financial planning is very client- and fact-specific. “The election results have not changed my multi-year planning,” he explained. “Our theme for most clients continues to be: accelerate income and accelerate charitable contributions of highly appreciated stock to get the deductions this year as they could be curtailed.”

He still thinks that taxes will be going up at some point, if not in 2021 then in the next few years. This view is shared by some of the other financial, tax, and legal advisors I reached out to. With this prediction in mind, multi-year planning with stock comp would focus on known dates for future restricted stock/RSU vesting and creating a strategy for when to exercise stock options.

Randy Joseph, a CPA with the tax-advisory firm Joseph & Hetrick (Seattle), also takes a multi-year-planning approach that goes beyond what tax rates might be in 2021. “We are cautiously discussing accelerating income and discussing the fact that no one knows what will happen. It’s such a crap shoot.”

Joseph M. Schmerling, a financial advisor and CPA with Schmerling Financial Group (Jenkintown, PA, and Silver Spring, MD), explained to me that year-end tax planning 2020 is different for many reasons. These include not just the tax proposals of President-Elect Joe Biden but also the impact of Covid-19.

“Our approach is to get ahead of disruptions by reviewing our clients plans and stress test the possible outcomes. Ultimately, we are looking for solutions that make sense even within the current fiscal environment,” he said.  “We are not willing to derail the financial progress we’ve made on speculation.”

Estate And Gift Planning For Company Stock

The lifetime exemption amount for gift, estate, and generation-skipping transfer taxes increased in 2020 to $11.58 million per person ($23.16 million for married couples). Lauren Galbraith, an attorney with the law firm Farella Braun + Martel in California, explained in a pre-election article at myStockOptions that by making gifts now, you can lock in the current amount of the exemption, which may shrink in 2026 to about half those amounts—or perhaps even sooner, depending on voting results (see Estate Tax Planning For Large Company Stock Holdings: Four Tips For Using Record-High Lifetime Exemptions).

Now, after the election, she told me this change is probably not coming in 2021. “I do think that the urgency has fizzled and estate and gift tax changes effective retroactive to January 1, 2021, at this point seem highly improbable. Those who are on the margins in terms of whether they want to make significant gifts now may be best advised to hold off and take a wait-and-see approach.”

Bob Keepler, a CPA with the tax advisory firm Keebler & Associates (Green Bay, WI), calculates using basic probability a 25% chance (i.e. 50% x 50%) that the Democrats could take control of the Senate after the Georgia runoff elections. Rather than trying to “see through the fog,” his wealthy clients with substantial assets are going forward and still making gifts to reduce the size of their estates.

He believes that if tax changes do not happen in 2021, they may still occur after the mid-term elections in 2022, as 21 of the 34 Senators up for re-election are Republican. At the very least, he observes, the current tax laws will sunset at the end of 2025.

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