Individuals who have worked at a company that went through an initial public offering and were compensated in stock options, restricted stock units or other equity should evaluate their tax situation before year-end. Because the stocks from an IPO are considered income earned, the value of the stock earned at the time of the IPO can be taxed as income.
Many recent IPOs (e.g., Lyft) have been valued highly at the time of the IPO, so the income could be significant — and subsequently have dropped significantly. Those individuals could therefore have a large, unexpected tax bill for that tax year. In some cases, the individuals could experience a liquidity crisis in which they were not paid enough income in dollars to cover the tax bill. They may be forced into selling some of their earned stock in order to cover their tax liability. Of course, if they sell the stock, they are also potentially realizing capital gains on the sale. In extreme cases, if the price of the stock has dropped before they realize they owe income tax on it, the proceeds from selling the stock may not be enough to even pay the tax bill. In this situation, an ounce of prevention — selling some of the stock soon after the IPO or after the lock-up period — could have saved individuals from a major liquidity crunch or insolvency.
This is a great opportunity for their CPA to advise the client to evaluate their situation before year-end, so that at least capital losses could be incurred in the same year the income was received, since capital losses do not carry back.
1. As a CPA, if you maintain a database of your clients, you likely have a list of their previous-year employers from their W2 forms. A database is also useful for helping your clients decide on the most accurate withholding and other questions they may have year over year, so we recommend keeping a spreadsheet in a database or Excel file nonetheless. You can even go one step further and send your clients a questionnaire during the year to check in on tax-relevant changes in their life, such as their employer.
2. At year-end you can do a quick search of employers to check if there was an IPO this tax year.
3. From the list of clients working at companies that went through IPOs, you can go one step further and check if the stock price decreased after the IPO.
4. In late November or early December, you can then reach out to those clients who had IPOs, and ask them about their stock and income from the previous year. Explain to them that it may make sense for them to sell their stock before the close of the tax year if the stock price decreased post-IPO.
5. Help them consider whether it makes more sense for them to sell all the stock before year-end so that they can realize all of the capital losses for tax purposes in the next year. Alternatively, they can hold onto the stock into the next year, but then if they need to sell the stock, they will have to carry the losses forward subject to an annual maximum. If they may have trouble paying their tax liability, it may be more practical for them to sell the stock before the close of the tax year.
