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🌼 Spring into action: Tax tips you may miss this year

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April showers bring more than just spring flowers…Hello tax season! With the tax due date just around the corner (April 18th this year, though some states, including California, have until October 16 due to weather disasters), a lot of you may be thinking: “Is that amount right? Geez, I owe a lot of taxes.”

Not to burst your bubble, but there are no “magic bullets” when it comes to taxes (though Vieje previously shared how tax law isn’t always so clear). But that doesn’t mean you can’t have a good tax strategy. For example, I recently worked with one founder to help him save nearly $20 million in taxes over the next five years, beginning with $1.5 million this year. It didn’t involve any tricks, it just involved understanding his financial — and equity — situation, knowing the right questions to ask, and developing a plan.

Your 2022 taxes are already set in stone but it’s never too early to start planning for next year. So, I wanted to share some unique tax insights — not the generic “max out your 401K!” ones you typically read about.

Schedule a call with me if you do need any help with tax planning, your stock options, or your financials, in general.

💳 Take back that AMT credit

If you’ve ever exercised incentive stock options (ISOs) you’re probably painfully aware of the Alternative Minimum Tax. The upside of paying AMT is that you can likely claw it back later — it’s basically a prepayment of taxes for the future.

In years where you don’t incur AMT, you can start recouping it. You may not be able to recoup it all back in a single year, but if you paid it last year or are planning to exercise any options this year, you should pay attention when getting ready to file taxes.

By the way, here’s an example of how one of our clients lowered their taxes by $33,000 with AMT credits!

Do note that the higher your income is in 2023, the more AMT credits you’ll be able to recover. Here’s an overview of how to claim AMT credits:

  • Review your tax return from the year you exercised ISOs and check to make sure you filed Form 6251. Based on Part II, Box 11, you should see the total AMT paid.
  • You’ll want to file a Form 6251 for your current year tax return as well, as this calculates the difference between your income tax and your tentative minimum tax. Based on the difference between your income tax and your tentative minimum tax, you can claim this amount of Minimum Tax Credit by filing Form 8801.
  • Your Minimum Tax Credit is then applied as a nonrefundable credit and is reported on the main page of your tax return (Form 1040), Box 20 to reduce your income tax liability dollar-for-dollar.

🚀 New startup, same QSBS

With so many in our community being laid off and seed and early-stage funding rounds easier to come by than late-stage funding rounds, the combination may be ripe for many to finally take the plunge to build their own startups. If history repeats itself, the next Airbnb or Slack could be founded (or was already started) during the current downturn.

The last economic recession is where many of today’s big tech companies found their footing and Amazon actually went public at the height of the Dot-Com Bubble. The upside of the downturn is that innovation doesn’t stop during recessions — if anything, they may feed it.

For those of you that are recent founders, are eager to launch your own business, or if you recently joined an early-stage startup, you should know about the Qualified Small Business Stock (QSBS). The IRS created Section 1202 to stimulate small business development and to incentivize people to take the risk of launching new, innovative businesses.

It’s likely you’ve heard of QSBS, but its benefits are limited to those that join a company when it’s still fairly small, which is why you want to take advantage of it when you can. The incentive allows stockholders to claim a minimum of $10 million in federal capital gains tax exclusion when selling their qualified small business stock at least five years after exercising it.

There are some other restrictions but, generally, QSBS is applicable to most tech startups. For more details, here’s a QSBS cheat sheet to reference. While the tax incentives can be enormous, the true power of QSBS lies within proper planning — many aspects of which I often see overlooked. Those include:

  • The five-year holding period applies to shares, not options. If you’re granted options in a company that qualifies for QSBS, you must exercise these options while the company still meets the criteria — the key metric is while the company remains below $50 million of gross assets — for these shares to be eligible for the capital gains tax exclusion when you later sell them.
  • If you’re granted options at a company that qualifies, you should request an “early exercise” provision within your option grant agreement, meaning you have the ability to exercise these options prior to the options becoming vested. If you choose to early exercise your options, you’ll also want to file an 83(b) election within 30 days of the exercise date. This notifies the IRS that you want to realize the income and any nominal tax liability now (while the company’s value / 409A is still very low) rather than at a potentially higher Fair Market Value in the future as your options vest.
  • If there is an opportunity for liquidity before the five-year holding period has been met, you can consider a 1045 rollover. Section 1045 of the tax code allows a shareholder to sell Qualified Small Business Stock within five years and roll the proceeds of the stock into another qualified small business within 60 days. This allows you to still preserve the QSBS status and maintain the holding period from when the original stock was acquired. Note: There are risks associated with this strategy and proper documentation is essential, so it’s important to engage a tax or financial professional to facilitate this transaction.

📉 Take advantage of a lower income year

Each year isn’t always created equal when it comes to income. Maybe you left your job to take some time off, or maybe you were laid off. While the latter is an obviously tough position to be in, and it can be hard to look at things objectively, a job transition is a time to look at your financial picture and see if you have any potential opportunities.

If you do find yourself transitioning between jobs or careers this year, and expect that your income will be lower, you should consider the following:

  • Exercising NSOs: If you were granted an extended post-termination exercise window — meaning, you were given longer than 90 days to exercise your stock options — those options convert from ISOs to NSOs after the first 90 days. NSOs are subject to ordinary income tax, unlike ISOs, so exercising some or all in a lower income year can reduce your overall cost. Plus, many companies have lowered their 409A this year (and many likely will if they haven’t), so that combination with reduced income could be favorable to mitigate tax exposure. Exercising options is an investment decision, so you should always evaluate the risks before making a decision. If you find yourself in this position, feel free to put time on my calendar.
  • Converting pre-tax dollars into tax-free accounts: If you have a 401K through a previous employee, and you’ve built up a balance in a “pre-tax” bucket, you can consider converting those funds to a Roth (tax-free) account. This typically makes sense if you anticipate that your 2023 tax rate will be lower than future years.

🚨 Beware the rising tax rates

We’re currently in a historically low tax-rate environment. If no new legislation is passed between now and the end of 2025, the current income tax rates and brackets that were enacted through the Tax Cut and Jobs Act (TCJA) of 2017 are set to sunset — meaning that tax rates will increase and tax brackets will be compressed.

Here are a few things you should consider over the next few years:

  • Funding post-tax (Roth) accounts: When it comes to retirement plans, you have two options for when you’ll be taxed on your funds: Now or in the future. Many people assume that paying taxes later is the best route, but that’s not always the case. If you are an early or mid-career tech professional, your earnings potential has significant upside in the years ahead, so paying taxes today and building up a tax-free retirement bucket could be incredibly powerful for you going forward.
  • Exercising NSOs: This is similar to the strategy I laid out above. Of course, there are many factors besides taxes that should go into an exercising decision, but if you’re optimistic about your company’s potential in the next few years, you could retain significantly more upside potential by exercising your NSOs while the current tax policy stands. Additionally, by holding exercised options for at least one year after the exercise date, you’re setting yourself to receive a lower tax rate (long-term capital gains) on any future upside for your company stock.
  • Exercising ISOs: Most taxpayers are not subject to Alternative Minimum Tax due to the AMT exemption (For 2023, $81,300 for Single Filers and $126,500 for Joint Filers). However, if you were granted Incentive Stock Options (ISOs) and the Fair Market Value (FMV, which is similar to 409A) of your company’s stock has increased since you were granted options, you may be subject to AMT upon exercising these options. The AMT exemption pre-TCJA was $55,400 (single) and $86,200 (joint), so considerably lower than what they are today. Additionally, the income threshold for phasing out of the AMT exemption is significantly higher today $578,150 (single) and $1,156,300 (joint), than it was in 2017 ($123,100 and $164,100, respectively). This said, if you hold options where there is a spread between the FMV and your strike price, the AMT associated with exercising these options is set to increase beginning in 2026.

🤝 The charitable kind

Another tax strategy you should consider is also a way to give back to your community. If you already do give back, you may not be getting the full tax benefit you could, especially if you don’t itemize your tax deductions, which many people don’t. If you do, you can “bunch” charitable donations into a single year for a bigger tax deduction: For 2023 it’s $13,850 for single filers and $27,700 for joint filers.

A great way to take advantage of this is through a donor-advised fund (DAF), which is kind of like a 401K but for charities. To make this easier for our clients in the startup community, we recently partnered with Daffy because they allow you to contribute cash as well as stock, crypto, or ETF to your DAF and receive a tax deduction in the year you contribute.

But, here’s where DAF’s can be incredibly powerful: If you donate securities that have been held for at least one year, you’re eligible to receive a tax deduction for the Fair Market Value of the shares you contributed. Not only does this mean you can avoid capital gains tax, a DAF allows you to distribute these funds to your favorite charities over multiple years.

For example, if you typically donate $3,000 a year to the American Red Cross, you may not be getting any tax benefits. But, if you set up a DAF and “pre-fund” three years of donations ($9,000 in total), you can “bunch” that donation (which may be through shares of public stock) into the same calendar year. Now, you can deduct all $9K for the 2023 tax year but still distribute the donation to the Red Cross over the next three years.

😬 Don’t get taxed twice on RSUs

There are two types of RSUs: single trigger and double trigger. Single-trigger RSUs are subject to a time-based vesting schedule like most stock options (i.e. four years), and are common at public companies. Double-trigger RSUs are common at late-stage, private companies which are still subject to the same time-based vesting schedule AND a “change of control” trigger, like an IPO or an acquisition. The reason for the second trigger is so that employees at private companies don’t have a tax liability without a way to sell their shares (Vieje covered why Stripe is trying to solve this issue with their $7B fundraise).

Let’s say you had RSUs vest in 2022. That income will appear in your W-2, in Box 1, since they are taxed as income. If you sold any RSUs in 2022, though, the sale of those shares will appear on Form 1099-B. Since the vesting and sale of RSUs are reported on two separate tax forms, it’s important to make sure you’re not getting double-taxed on that income!

You should check form 1099-B to make sure that the cost basis for when you acquired those RSUs (i.e. the value of the shares on the date of vesting), is recorded correctly. A common oversight is that the 1099-B form reports your cost basis as “0,” and the full proceeds get taxed as a capital gain AND it’s already been taxed on your W-2.

One thing to note is that RSUs are automatically withheld at 22% for Federal tax purposes for most people. If your effective tax rate is higher than 22%, because you’re a high earner, you’ll likely have a tax bill to make up for underwithholding. If that happens, or you think you’ll be subject to a higher tax rate, check with your employer to see if they’ll allow you to elect a higher withholding amount on supplemental income for 2023. Or you can also make quarterly estimated tax payments to avoid this issue.

👫 Don't go it alone

If you’ve made it this far, you can see why I said upfront that there aren’t any magic tricks when it comes to taxes. But, it's also not simple stuff, and you can see why it's easy to overlook or miss things.

That's why it's so important to have a partner that understands your financial situation and, for most of you, how private equity works.

If you need help with any of these strategies, or just want to get a head start on planning for 2023, I’m happy to help. Put some time on my calendar here.

I’m no magician, but a good financial advisor helps you cut through the noise, help you understand the best strategies for your situation, and implements the proper actions to put you in the best position — and save on taxes where you can.

Things we’re digging:

  • 🪟 Is the IPO window creaking open? WSJ is reporting Klaviyo is heading in that direction, as soon as September. The company is also reporting it’s profitable, a key metric in this market environment that could make the leap more likely. If they do IPO, and it’s a relative success, others waiting in the wings may also cross the threshold. If you think you’re company is on that list, feel free to put time on my calendar if you want to talk through your options.
  • 🚴 Riding that trend… Instacart has also raised their internal valuation by 18% — in line with NASDAQ’s rise this year — during a quarterly 409A evaluation. This could be good news for the grocery delivery company, as well as those eagerly awaiting new IPOs.
  • 🤣 Please be honest… Sometimes, it’s good to not take ourselves too seriously. I love (and personally use) many of these products, but I still got a good chuckle out of these honest headlines.

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