What To Expect When You’re Expecting To Go Public

Your company going public can be an exciting time full of growth and new opportunities. Before the initial public offering, or IPO, it may be helpful to prepare by brushing up on how different types of equity are taxed on a federal level and the tax planning strategies available before and after an IPO. State and local taxes may vary. 

Taxes for Different Types of Equity Compensation

When it comes to equity compensation, different types of awards attract different tax treatments:

• Restricted stock units (RSUs) that are stock settled deliver company shares when certain vesting requirements are met. Once RSUs vest and are settled in shares, their market value at the time the shares are issued is subject to ordinary income tax. To help executives cover the taxes owed on vesting and settlement, some private companies provide for “double trigger” vesting in their plan document or RSU grant agreement that states that RSUs will vest only after a liquidity event, such as an IPO. When you sell your shares, you’ll realize capital gains or losses for federal tax purposes based on the differential between the sales price and the fair market value at the time of vesting and settlement. Shares held for more than a year receive long-term capital gains (or loss) treatment for federal tax purposes.

 

• Restricted stock awards (RSAs) are also subject to federal ordinary income taxes on vesting, but by making an 83(b) election, you can pay federal ordinary income tax upfront based on the value of your shares on the grant date. This establishes your cost basis for federal tax purposes. Sales of shares after vesting is then subject to capital gains taxes for federal tax purposes for any gain above the cost basis. The downside? If the stock price falls or you leave the company before vesting, you cannot get a refund or credit for the taxes you have already paid.

 

• Stock options give you the right to buy shares at a pre-set price (the “strike price”) and option holders typically exercise vested stock options when the company’s stock price exceeds the strike price. For private companies, the strike price is commonly determined by a 409A valuation. The tax treatment depends on the type of option exercised. Exercising non-qualified stock options (NQSOs) results in federal ordinary income tax, while selling the underlying shares results in either short- or long-term capital gains taxes for federal tax purposes, depending on how long you hold the shares. Exercising incentive stock options (ISOs) may trigger the federal Alternative Minimum Tax (AMT), but you can benefit from long-term capital gains tax rates for federal tax purposes if you hold the underlying shares for at least one year after exercise and two years after the grant date.

 

• Stock appreciation rights (SARs) represent a promise to pay an amount based on the appreciation of company stock over the stated exercise price and may be settled in shares or cash. Like options, the intrinsic value at exercise is considered ordinary income for federal tax purposes. 

 

Pre-Liquidity Tax Planning

If you’re looking to get the most out of your equity compensation when a liquidity event is on the horizon (but hasn’t happened yet), you may want to consider these two strategies. Note that both strategies can be complex and depend on the specifics of your plan. We recommend you seek legal and tax advice before implementing either of these.

• Early exercise: If you’re bullish on your company stock, exercising your options before an IPO can “start the clock” on qualifying future appreciation as long-term capital gains. If the company goes public at a value higher than the exercise price, you could save significantly on taxes. However, if the company stock falls, you may be unable to recover the taxes triggered by the exercise.

 

• Transfer Tax planning: A way to potentially minimize transfer taxes (federal, and potentially state, estate and gift tax) involves gifting pre-IPO shares to a beneficiary (who is not a U.S. citizen spouse) to use all or a portion of your 2024 federal estate and gift tax exemption that excludes up to $13.61 million of gifted assets from federal estate tax. Due to restrictions on gifting certain types of equity compensation (including RSUs, RSAs and ISOs), the cleanest path for transfer tax planning involves gifting outright shares, if such gifts are permissible under the applicable federal and state law. 

 

Post-IPO Sales

Once your company is public, you may imagine it gets easier to sell your shares. Ultimately, selling shares can be easier once your company has gone public but it’s important to be aware of other factors impacting any shares sales, post-IPO.

Lock-up periods restrict employees from selling shares immediately post-IPO, and corporate executives can generally only sell shares during “open trading window” periods—usually for four to six weeks after each quarterly earnings release. Even during those times, material non-public information provisions or if you are under insider trading restrictions under Rule 144, as well as rules within your company-specific agreements, may prohibit you from transacting in company stock post-IPO. Be sure to review your company documents to understand the specific details of your plan, and what is allowed.

A Customized Approach

To help you get the most out of your equity awards, both pre- and post-IPO, you may want to consider working with a Financial Advisor who can help you understand your specific circumstances and help you work toward your unique financial goals.