Welcome to part-2 of this two-part series. In this post, I will continue helping my readers with understanding how RSU IPO taxes work. Here is a link back to part-1 of How RSU Refresh Works in case you missed it or need a refresh (*wink emoji*😉 — did you get my pun? LOL.)
If you work in the Bay Area for a public technology company, as I do, then part of your salary is paid in Restricted Stock Units (RSUs). I have explained how RSU works in another post which you can check out here. Many of my readers have been asking about how RSU refreshers work as part of their total compensation. Another hot topic is how RSU IPO taxes work. In order to explain how stock RSU refresh and RSU IPO taxes work, I will split the information across a two-part series. Welcome to part-2 of this two-part series.
- For part-1, I will explain how stock RSU refresh works and how they combine together to increase your overall pay.
- For part-2, I will explain how RSU IPO taxes work when showing a profit or claiming a loss.
Related Post: Are RSUs Taxed Twice
Silicon Valley Start-ups
When people think of Silicon Valley, they immediately think of Silicon Valley as being synonymous with start-ups. The excitement that comes with working at a start-up that could disrupt an industry like delivery on demand or taxis is what most fresh college grads dream of. However, I tend to favor public companies over start-ups because of the risks inherited with start-ups which have over a 90% failure rate. Still if you happen to get lucky and land at a start-up that makes it to IPO, you will have a lottery ticket of possibly becoming rich over-night.
The biggest allure in working for start-ups is being paid with RSUs. Because start-ups do not yet have the financial ability to pay employees large base salaries, they will often make employment offers with large pre-IPO RSU packages. If you are not familiar with RSUs, you can check out what RSU post here. RSUs have no monetary value until the start-up experiences a liquidation event. A liquidation event can consist of
- Start-up company receives a buy-out offer where the private shares are purchased at an agreed upon price.
- Start-up company merges with another company for an agreed-upon exchange of private shares defined by terms of the merger. Terms could be anything from rewarding new RSU shares or trading 2-for-1 shares with a public stock.
- Start-up company files an initial public offering to be listed on the stock exchange where a subset of private shares are offered for sale to public investors.
- Start-up company goes bankrupt which happens 90% of the time. I would argue that the RSUs are worth less than toilet paper at this point. Because at least with toilet paper you can still wipe your…
What is an IPO
An initial public offering (IPO) refers to the process of when a private company, like a start-up, offers private shares to the public in a new stock issuance. Public investors can then purchase fractional ownership in the form of stocks which allows a company to raise capital to fund the business.
Here is where things start to get diluted. To “fund the business” can mean many things. For example, public money can be used to cash out early investors such as Venture Capitalists or famous people who had the money to invest in the company to begin with.
The rich get richer and the poor get poorer.
https://en.wikipedia.org/wiki/The_rich_get_richer_and_the_poor_get_poorer
However, buying an IPO stock is not always a bad thing because think about those public investors who purchased Google, Amazon, or Facebook where these companies are now worth more than $1,000,000,000,000 dollars in market capital value (yes that’s right — trillion has 12-zeros in it). This is also how employees who decided to stay with a company long-term can really improve their net-worth and prosper instead of job-hopping. And I am not talking about the fresh graduate kid who landed his first job at Google in 2020. I could care less about that kid. I am talking about the older employees who have been with Google 8 plus years. Imagine all the RSU refresh packages those employees received combined with their 6-figure base salary. Now you can understand how easily some of these people afford homes in Silicon Valley that average more than $1,000,000. Easily.
Related Post: Afford a Home in Silicon Valley with an ADU
RSUs from an IPO
I want to help those who are not familiar with how RSUs work especially during an IPO. This topic is exactly why I chose to start this blog a few years ago. I am here to help my readers as well as my fellow Silicon Valley employees start their financial independence journey.
In 2019, many IPOs were filed including Lyft, Uber, Slack, Zoom, and Pinterest. The world thought that all the employees working at these companies were about to join the exclusive millionaires club, especially the real estate world. The truth is that the majority of these employees did indeed experience a large sum of money when their stock vesting dates were reached. When a stock vesting date is reached you should expect to pay the first RSU tax event. If you need to review the basics of how RSU taxes work please read my previous post. Vested stocks are counted as part of your ordinary income tax just like your base salary pay.
The first tax event is on the RSU vesting date when the scheduled unvested shares amount becomes vested. Not to be confused with RSU grant date which is not taxed. The RSU grant date only tells you how many shares you will be given based on the valuation price at the time of this event. The RSU vested amount is added to your W2 Form and taxed as ordinary income calculated from the stock price on the vesting date.
Therefore, when a company finally goes IPO is how you determine the true value of the RSUs you hold. In short, the company value is based on how the public perceives the value of the start-up’s business value and it’s future potential (i.e. flying cars, legal weed, artificial intelligence). The vesting date is different than the IPO date but they can be the same date as with the case for Uber.
What happens to the Taxes from an IPO
How the company is perceived by public investors is very arbitrary. There really is no mathematical formula to accurately predict how well a company will do. Many financial experts rely on historical performance patterns as an indication of how it will continue to perform. However, that is like betting on the roulette wheel after it hits 10 red numbers in a row. There really is no true correlation based on the historical trend, only a person’s opinion. BTW I would bet black because I bet on trends breaking, but I am sure there are people reading this right now who would bet red. Let me know in the comments. =)
When a stock vesting date is reached you should expect to pay the first RSU tax event. Vested RSU stocks will appear on your W-2 Form as ordinary income and will be subject to the same tax as your base salary pay. Pre-IPO employees expect to pay for this tax by selling stocks from the second RSU tax event to pay for the first RSU tax event. The lockout period determines when you are allowed to sell your vested RSUs which means a couple of scenarios could play out while you wait:
- RSU Taxes when an IPO price goes Up
- RSU Taxes when an IPO price goes Down
RSU Taxes when an IPO price goes Up
Predicting how an IPO will perform is really a guessing game because you have no historical references and no financial reports to evaluate. Nobody seems to care about the details when your IPO is doing well. I am sure Facebook employees remember their IPO price of $38 per share in May 2012 and then watched it sink 52% to $18.06 after only 3-months. Luckily, most 1st year vesting dates (sometimes referred to as a lockout period or 1st year cliff) forbid employees from selling shares until after 12-months. I am not sure what the exact terms were for Facebook RSU IPO shares, but the lockout period saved them from having to sell at a loss due to the vesting date being after the IPO date. And the subsequent vesting dates were all positive gains after 16 months from the Facebook IPO date. I am pretty sure Facebook IPO employees were more than happy to sell share profits after 16-months.
- Facebook (FB: NASDAQ) $38 May 25th 2012 (IPO price)
- Facebook (FB: NASDAQ) $18.06 Aug 31st 2012 (3-months later; 52% loss)
- Facebook stock price $24.35 May 31st 2013 (1-year later; 36% loss)
- Facebook stock price $50.23 Sep 30th 2013 (1-year and 4 months later; 32% gain)
RSU Taxes when an IPO price goes Down
Everybody is apathetically happy to sell stock gains from the second RSU tax event to pay for the first RSU tax event. But what happens when you have to sell at an IPO loss? *cough* Uber employees *cough*
Let’s review again. When a stock vesting date is reached you should expect to pay the first RSU tax event. Vested RSU stocks will appear on your W-2 Form as ordinary income and will be subject to the same tax as your base salary pay. Pre-IPO employees expect to pay for this tax by selling stocks from the second RSU tax event to pay for the first RSU tax event.
Do you have a rich Uncle?
Your start-up normally deducts this amount automatically by selling your RSU shares after the lockout period expires. I assume this was the case that happened to Uber employees. In other rare cases, some start-ups allow employees to pay for the taxes with their hard-earned cash as payment deductions from future paychecks. Unless you have enough cash to cover such a large tax bill in a lump sum payment. You will need to pay 32% in taxes for $1,000,000 vested RSUs. Maybe you have a rich uncle who has $320,000 just sitting in the bank.
Why did Uber move the Vesting date up to the IPO date?
Uber was actually trying to help their employees save on income taxes by moving the vesting date up to be the same as the IPO date. Uber had a lockout period of 6-months after the IPO date where normally the vesting stock price is determined on the same day. Some Uber employees are planning to file a lawsuit against their former employer for moving the vesting date up to the IPO date. The strategy behind the decision to move up the vesting date was that Uber leaders felt that the stock would rise higher than the IPO price of $45 per share after 6-months. This strategy would have paid off brilliantly for Google IPO employees whose stock gained 90% after 6-months.
- Google (GOOGL: NASDAQ) $50 Aug 19th 2004 (IPO price)
- Google (GOOGL: NASDAQ) $95 Feb 17th 2005 (6-months later; 90% gain)
Unfortunately, this strategy did not work out in favor for Uber IPO employees because the stock fell 42% after 6-months.
- Uber (UBER: NYSE) $45 May 10th 2019 (IPO price)
- Uber (UBER: NYSE) $27 Nov 7th 2019 (6-months later; 42% loss)
Claim Capital Loss up to $3000
When you lose money on a realized stock investment, you can claim a capital loss on your taxes to reduce your AGI. Uber employees will have to file taxes claiming a loss on those RSU IPO shares sold to cover the tax bill. Uber employees are really not losing anything here because Uber is not bankrupt so the stock shares still have value. The calculation required is the same as the second RSU tax event except that the vesting stock price is taken from the IPO date (i.e. $45 per share) while the sale date is still the vesting date (i.e. Nov 7th 2019).
For example, let’s pretend Jane Doe worked for Uber and was given 10,000 pre-IPO Uber shares.
- 10,000 shares x $45 IPO price = $450,000 (cry me a river for only making half-a-million; boo-hoo for Jane)
- $450,000 x 32% tax = $144,000 taxes owed
- $144,000/$45 = 3,200 shares of RSU IPO sold-to-cover taxes automatically
- $27 – $45 = $(-18) capital loss Jane can claim per share sold
- $(-18) x 3,200 shares = $(-57,600) Jane can claim only $3,000 per year
Options for Capital Loss
Here are a couple of options for capital loss claims.
- claim $3,000 capital loss on tax to reduce AGI
- offset capital gains from stocks that have profit
The US tax law allows a capital loss claim of up to $3,000 annually. The worst Jane can do is subtract $3,000 from her AGI over the next 19 years until she reaches $(-57,600) total. Jane could also consider offsetting any capital gains she has from stock investments. Jane still owns 6,800 shares of Uber that she will eventually sell (and maybe go buy a Silicon Valley home with an ADU). If Uber stock turns around and rises like the way Facebook stock did 16-months later, Jane will now have a unique opportunity of being able to offset the capital gains with the capital losses claimed on her taxes. Pretty sure Uber IPO employees would be extremely happy about tax-free capital gains on their stocks.
Quick Summary
When a stock vesting date is reached you should expect to pay the first RSU tax event. Pre-IPO employees expect to pay for this tax by selling stocks from the second RSU tax event to pay for the first RSU tax event.
Uber was actually trying to help their employees save on income taxes by moving the vesting date up to be the same as the IPO date. Unfortunately, this strategy did not work out in favor for Uber IPO employees because the stock fell 42% after 6-months. If Uber stock turns around and rises like the way Facebook stock did 16-months later, Uber employees might have a unique opportunity of being able to offset the capital gains with the capital losses claimed on her taxes.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services.
