Welcome to the 2nd edition of the Tech Financial Planning Newsletter.
I had the chance to interview a friend who’s been in the tech industry for almost 10 years. He started with a couple smaller companies and then got hired by Uber, where he was with them through their IPO. From there, he joined a startup which ultimately didn’t work out, and now is at Netflix.
We chatted through his experience navigating the equity compensation world, particularly RSUs, and the learning lessons he gained along the way. As you will see, it can build great wealth, but it doesn't come with instructions.
Here are 7 of his top lessons from his time in tech so far.
Lesson 1: Equity Compensation Is A Tool
RSUs are a nice supplement to my income. As I moved up, both in different positions and different companies, I got larger bonuses and awards. The total compensation (salary, cash bonus, equity) can be sizable each year.
One thing I have done well is use RSU compensation as a starting point for salary negotiations when looking at new jobs. That’s one common mistake I see: most companies have wiggle room, and you can potentially get a lot more.
It really helps to have multiple offers. If I was looking at two or three potential companies, Company A might have a higher base pay, Company B might have a higher cash bonus, and Company C might have a higher amount of equity compensation per year. I would use that information and go back to them and see if they could match part of the offers from the other companies.
For example, with Company A with the higher salary, I’d see if they could match (or go higher) the equity compensation that Company C was offering.
By doing this, I was able to negotiate a higher total compensation for myself several times.
Lesson 2: The IRS Wants Their Piece
Always think about taxes and what tax event is (or could be) triggered when you take action. Most of the time we think about when we sell stock, but there are other events that can have tax impacts like exercising stock options or when your RSUs vest.
Obviously, we want to maximize our dollars and our money, preferably while paying the IRS as little as legally possible. But sometimes you can make things too complex in the name of “savings on taxes.” Sometimes I am willing to take a bigger tax hit in order to keep things simple.
I’d like to add that I do my own taxes. I know what to keep track of, particularly complex calculations or taxable events over several years. I would recommend that most people use a CPA who will track the important items and do the calculations for you.
Joe’s note: Sometimes we call this not letting the tax tail wag the dog. While taxes are important, they can’t be the only focus.
Joe’s note: You should consider most actions (with some exceptions like when stock options are granted) to be taxable. This can be tough, especially when a company hasn’t gone public. You might owe taxes but you probably can’t sell the stock!
Lesson 3: Have a plan to sell
One thing I should have done is sell more consistently.
One of my first jobs was at a big public company who IPO’d during my time there. It had a nice initial pop but it’s had a rocky few years. And for me (and many people in tech), I had too much money tied to one company’s stock. It works great in the good times, but when things inevitably hit a rough patch, it can be a huge hit.
It’s tough to balance enthusiasm for your company with diversification. In hindsight, I drank a bit of the Kool-Aid. As part of the company, you listen to leadership and see what’s on the company road map, so it’s easy to get too excited. Especially when the stock is down.
You think it’s just a matter of time before the stock jumps back up.
If I could do it over, I should have set up a schedule to sell my stock and been disciplined to stick with it. I should have sold more consistently instead of hoping.
Then, I could have used that extra cash to diversify, fund goals, or make different investments (some conservative, some riskier). For example, as soon as I left the company, I completely sold out of my company stock so that I have money for a house and dry powder for other investments.
As far as what shares to sell, here are some things to think about:
All things being equal, sell shares held long term over short term so you have lower taxes
Immediately sell my acquired ESPP shares as soon as they hit
I would sell my shares with the lowest amount of gain. Often, these were my most recently acquired shares (often recently vested RSUs). This way, the gain was small and I could do some selling without hitting the wash sale rules)
Joe’s note: We see this a lot. People get excited about their company’s future, which is a good thing, and leave too much of their net worth exposed to one company.
Which is why it’s important to have a strategy for selling. It’s worth noting that everyone’s situation is different. A single 30 year old who is planning on working another 30 years is in a very different position than someone who’s 60, married, and wants to retire in the next 5 years. The 30 year old might be comfortable with holding onto a little bit more company stock.
If you need help, schedule some time to talk here.
Lesson 4: Watch out for the wash sale rule
This is one I learned the hard way. When you sell RSUs (or any company stock) at a loss while you are acquiring new shares (like vested RSUs), you may get hit with the wash sale rule.
A wash sale happens when you buy or sell a security like a stock at a loss. But either 30 days before or after, you buy (or acquire) one that is “substantially similar.”
If you do, you can’t immediately take the tax deduction to offset other gains or offset income (see Joe’s note below)
At public companies, this can happen pretty easily with RSUs vesting and limited open windows.
For example, let’s say your open window is from May 5th to June 15th. This is the only time you can sell for the quarter.
But, your RSUs vest on May 20th. As we can see, there’s no period 31 days before or after May 20th that you can sell within the open period.
So let’s say you sold on June 5th for a $10,000 loss. Normally, you can use that loss of $10,000 to offset other gains you have, or offset income (up to $3,000 in a year).
But because it’s within the 30 day window, you can’t take that loss.
Plus it adds complexity because it is difficult to track and makes things more complicated come tax time.
Joe’s note: Sometimes you can’t avoid the wash sale. Perhaps you need to sell because you need some cash or it is part of your diversification plan. There is some good news. If you use the funds to purchase the exact same stock, the amount of your loss is added to your cost basis.
So the tax deduction has been postponed to the “new shares.” You won’t get the tax deduction until you sell this set, but beware. Depending on timing, this can trigger a new wash sale. It can get complicated!
If you want to read more about the wash sale, this article is a great resource.
Lesson 5: Your company might not withhold enough in taxes
This can be a huge surprise come tax time.
Depending on your situation, what your company withholds for taxes may not be enough. If this is the case, you will find yourself owing the IRS.
This depends on items like your tax bracket and how much compensation you received from RSUs, but if you aren’t prepared, it can be a huge hit.
If equity compensation is a big part of your total earnings, this can cause a lot of stress and anxiety. Especially if you are doing things on your own. You try to set aside enough during the year to pay for excess taxes, but you aren’t exactly sure if you are doing enough.
One thing I started doing that helped was making estimated tax payments. This way, I paid a bit throughout the year. But to do that right, you need to be able to make some reasonable projections about income, equity comp, etc.
Joe’s note: I wrote a more in depth article on this about what happens when your RSUs vest. In short, the amount your company withholds is merely an estimate of the actual tax liability.
For example, if you are in the 32% tax bracket and your company only withholds 22%, you will have to make up that missing 10% come tax time.
Lesson 6: Unintended Consequences
It’s important to remember that many types of equity compensation, particularly RSUs, are counted as income. So not only will you be taxed on this, but as it bumps up your taxable income, it can have some second order effects like:
Bumping you into a higher tax bracket
Making you go over the Roth IRA contribution limit
Causing you to pay the Net Investment Income Tax (extra 3.8% tax on investment income)
Potentially phase you out of other tax credits and deductions
Joe’s Note: This is why it’s so important to have a plan! With equity compensation, there are so many moving pieces.
Lesson 7: It might make sense to hire someone
You can figure it out on your own through a lot of trial and error, or you can hire someone to help you.
For most of my life I have been more of the DIY type. After a few years, I finally have a solid handle on things, but as you can see, I made a number of mistakes along the way
If you aren’t a DIY-er, hire someone to help. That can be a good tax preparer, financial advisor, or both. But you will want to a) make sure they have expertise in your situation and b) talk to them early.
If the professionals you work with aren’t familiar with RSUs, ISOs, and ESPPs, they probably aren’t the right fit.
And don’t wait until the last second to talk to them, or wait until after you’ve made a decision. There’s a lot that can be done through proactive planning
Joe’s Note: it may make sense to work with a CPA or an advisor who can help you work through the numbers. And like he says, it makes sense to work with someone earlier than later. I’ve run into situations this past year where we could have saved people tens of thousands of dollars in taxes if we started working together earlier.
Interested in talking more? Grab some time on my calendar
Miscellaneous thoughts
Mergers and acquisitions are complicated. Get on that early with your CPA. I've learned even CPAs have to navigate through the different tax rules triggered by the acquisition.
The longer you've been at a company the more complicated potentially your situation is going to be.
IPO and liquidity events are great because your shares finally become real money. They are worth something. However, it's important to remember all those shares you accumulated become income on that one day. It can mean you owe a LOT of money. Again, see lesson #5 - what is withheld may not be enough. So be prepared.
Joe’s Note: this will depend largely on what type of equity compensation you receive. But one example we are referring to here is double trigger RSUS. This means that two specific events must happen before you own the shares. Typically, the first trigger is your usual time-based vesting and the second is a change in control or a liquidation event like an IPO.
If this is the case, this could mean years of RSUs will all become income in one year, which could lead to one heck of a tax bill.
Final Thoughts / Summary
Like we said up front: equity compensation can be a great tool, but it doesn’t come with instructions. There’s a lot of complexity involved, and everyone’s circumstances are very different.
The big takeaway: make sure you have a plan for your equity compensation, your income, and your other goals and dreams.
Hopefully this interview provoked a few thoughts and questions for your own situation. If you have further questions, I’d love to talk!
This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product. Hypothetical examples contained herein are for illustrative purposes only and do not reflect, nor attempt to predict, actual results of any investment. The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed. Please contact your financial, tax, and legal professionals for more information specific to your situation. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.