Babylon Wealth Management is a dedicated financial advisor for technology, software, and start-up professionals and executives in the San Francisco Bay Area and nationally. We are committed to bringing simplicity in your complex world of equity compensation, employee stock options, restricted stock units, deferred comp and Employee Stock Purchase Plans. Our mission is to provide unbiased and trustworthy financial advice to help you make well-informed decisions considering your financial goals, risk management, and tax implications.
Words from our founder
I grew up in an environment which appreciated strong technical and math skills. Therefore, I chose a career in Finance, and spent more than ten years on Wall Street, working with stock options and derivatives. This experience is instrumental when I work with tech professionals and help them solve complex financial and tax situations.
Why tech professionals have unique financial needs?
Tech professionals and executives have distinctive financial needs based on the unique characteristics of the tech and start-up industry. Most tech professionals receive a portion of their earnings in the form of equity compensation. Equity compensation could range significantly from the company to the next. Additionally, personal and family circumstances can contribute to the additional complexities of your financial life.
What is Equity compensation?
Many tech professionals and executives receive equity compensation supplanting their regular earnings. Equity compensation gives the employee a stake in the ownership of the company. Equity compensation can be a great source of wealth for many technology and startup professionals and executives.
What are the main types of Equity compensation?
Employee Stock Options
Employee Stock Options (ESO) are a favorite tool by employers to attract, reward, and retain top talent. ESO is a contract between the employee and the employer, giving the employee the right but not the obligation to purchase company stocks at a pre-determined price in a set period.
Like exchange-traded call options, ESOs allow their owners to benefit from the rise of the company stock. However, there are significant differences. There is no public market for ESO. They can be extended for up to 10 years, while most exchange-traded options expire within a year or two. Furthermore, the employer sometimes can change the strike price of the ESO while this is not possible for exchange-traded options.
Non-Qualifies Stock Options
Non-qualified stock options are usually granted to company employees, but they can also be given to vendors, clients, and the board of directors. They can be exercised at any time between their vesting date and expiration date. They offer more flexibility than Incentive Stock Options but have less favorable tax treatment. The key requirement set by the IRS for NSO is that the exercise price can never be less than the fair market value of the stock as of the grant date.
The receiver of non-qualified stock options will pay income taxes on the difference between the stock market value and exercise price at the time of NSO exercise.
If you decide to hold on to the stocks after the option exercise, you will owe long-term or short-term capital gains taxes depending on your holding period.
Incentive Stock Options
Incentive Stock Options (ISO) are only granted to company employees. They can exclusively be vested for up to $100,000 of underlying stock value each year. ISO must expire after ten years. They are not transferrable. ISOs have a preferential tax treatment. The tax rules for ISOs allow their owners to pay long-term capital gains if certain conditions are met.
Long-term capital gain tax is due on the difference between the sale price and the exercise price. To receive this tax benefit, ISO holder must keep the stock for one year and one day after the exercise date and at least two years and one day from the grant date.
If the sale date does not meet the above requirements, ISO is disqualified as such and treated as NSO. In that case, you will owe ordinary income tax and short/long-term capital gain taxes
Alternative Minimum Tax is applicable on the difference between market price and exercise price in the year of exercise. You have to report the difference (also known as the bargain element) to IRS. This may have an impact on your final tax at the end of the year, depending on various other deductions.
Restricted Stock Units (RSUs)
A restricted stock unit (RSU) is a type of equity compensation given by an employer to an employee in the form of company stock. Employees receive RSUs through a vesting plan and distribution schedule after achieving certain performance milestones or upon remaining with their employer for a set period. RSUs give an employee interest in company stock, but they have no tangible value until the vesting is complete.
The fair market value of your vested RSUs is treated as personal income in the year of vesting. Typically, companies withhold part of the shares for federal and state income taxes. The remaining shares are given to the employees. At this point, you can decide to keep all shares or sell them at your wish. If your employer doesn’t withhold taxes for your vested shares, you will be responsible for paying the corresponding taxes during the tax season.
Restricted stock awards are a type of equity compensation where the employer rewards corporate insiders, executives, and employees based on performance milestones. Unlike RSUs, restricted stock awards come with voting rights immediately because the employee owns the stock the moment the award is granted. The value of restricted shares becomes taxable when they are fully vested. Employees who choose to keep the shares and sell them later in time, will realize either short- or long-term gains or losses and pay taxes accordingly
Employee Stock Purchase Plan (ESPP)
Employee Stock Purchase Plan (ESPP) is a popular tool for public companies to allow their employees to participate in the company’s growth and success by becoming shareholders. ESPP gives you the option to buy shares of your employer at a discount price. Most companies set a discount between 10% and 15%. Unlike RSUs and restricted stocks, the shares you purchase through an ESPP are not subject to any vesting schedule restrictions. That means you own the shares immediately after the purchase.
All contributions to ESPP are pretax and subject to federal, state, and local taxes.
Purchasing your company stock will not create a tax event. You don’t owe any taxes if you never sell your shares. Once you decide to sell your company stock, the discount will be treated as ordinary income. Additionally, the difference between the selling price and the purchase price is considered a realized capital gain.
Non quailed deferred compensation (NQDC) plans are popular rewards and incentive tools for corporate executives and insiders. NQDC plans allow corporate participants to save and defer current income today and withdraw it at a future date. For many tech executives, deferred comp plans can be combined with stock options and RSUs. However, they do not provide bankruptcy protection by either party.
How can we help tech professionals and executives?
Robust Financial Planning is essential to achieving your personal and financial goals. As fiduciary financial advisors, we believe that your unique circumstances require tailored solutions targeting your specific needs and priorities. We will develop a personalized roadmap to help you meet your personal and financial milestones. Our firm uses the best-in-class fin-tech platform that allows creating collaborative, transparent and dynamic financial plans which update in real-time as your life and financial circumstances change.
Retirement planning is a natural extension of the financial planning process. Retirement and often Early Retirement is an essential goal for many of our clients. We work hard to make sure that you can pursue your dreams and retire with confidence and peace of mind.
Strategic tax planning
For many tech professionals, successful financial planning involves a strategic and effective tax strategy. Our goal is to make sure that you get the most out of your equity compensation. Many of these financial and tax decisions will evolve through the various stages of your company’s business cycle. We encourage you to contact us as early as possible so that we can take a proactive (not reactive) approach in solving your complex tax circumstances.
Section 83(b) election
The tax code allows certain stock option and restricted stock award owners to elect to pay an ordinary income tax based on the fair market value of the stock on the day it is granted. Section 83(b) election provides a lucrative tax-saving opportunity for many tech and startup professionals. Contact us if your company offers 83(b) election and if it makes sense for you to pursue it.
Section 83(i) election
A relatively new change in the tax code, section 83 (i) permits qualified employees of eligible private companies to elect to defer, for up to five years, the income recognition related to exercising of stock options or vesting of stock rewards. Under section 83 (i), when an employee makes a deferral election, the “deferral stock” begins its holding period for long-term capital gain tax treatment on the date the qualified stock is transferred to the employee. The employee will not pay taxes on the value of the qualified stock for up to five years. The long-term capital gain holding period and the deferral period will run simultaneously.
Managing concentrated positions
Having concentrated positions of company stock and stock options is a common premise for tech professionals and executives. While concentrated positions could be an enormous source of future wealth, they are also representing a risk to our clients who have short-term and near-term financial needs. Additionally, having concentrated positions require a suitable long-term investment, tax, and exit strategy.
Managing sudden wealth and extra cash
Receiving sudden windfall is a dream of many hardworking tech professionals. While sudden wealth can bring a lot of exciting changes in your life, it can also have a variety of financial, legal and core repercussions. We strongly encourage you to form a team of financial and tax professionals who can address all your questions in a timely and proactive fashion.
Corporate executives 10b5-1 plan administration
Rule 10b5-1 is a safe-harbor way for corporate executives and insiders to sell company shares. It requires them to establish a trading plan with a third party that will sell the stock. The plan will include written formula and methodology of determining the number of shares to be traded at given point in time and price level.