Got Stock Options? Don't Miss These Year-End Tax Moves With Ally Jane Ayers (EP.182)

0:28We all need to make smart decisions with our money. who is the co-founder of Brooklyn FI and host of the Liquidity Event podcast. I asked Ali Jane to join us because she is a leading expert in the complex world of stock compensation. And so whether you're a private company employee who is holding stock options or someone trying to navigate RSUs at a public company, I think you'll really find her insights are very practical and they can help you maximize your wealth and minimize stress. So we're going to take a deep dive into some of those critical tax considerations for year-end planning and expand into strategies that will help you align your financial goals with your long-term equity compensation plans.

1:12As always, you can visit thelongterminvestor.com to find detailed show notes, but you might also want to navigate and click on the resources tab because there's a document in there called how to interview an advisor that I think you'll find very interesting. And if you're looking for some guidance on how to navigate these complex topics, that might be a really good place to start. But enough of me. Let's get to it. Here is my conversation with Allie Jane Ayers. Welcome to the Long-Term Investor. In the sidecar today is Allie Jane Ayers, co-founder of Brooklyn F.I., also the host of the Liquidity Event and an expert on all things equity compensation.

1:56Allie Jane, thanks so much for joining the show. I'm so happy to be here. Thank you for having me, Peter. Well, I told you in advance because this is a topic that I think I trip over a lot and listeners trip over a lot, that you're going to really help us sort some things out here when it comes to year-end planning. Maybe we can just start there. What do you feel like are some of the most important tax considerations for year-end planning with stock compensation? Yeah, so stock compensation, when we think about stock compensation, we have to think about taxes. and often people who are in the wonderful privileged position of being compensated by both a salary and also stock in a private or public company, they have to think about taxes, right?

2:36So as we approach year end, the year's almost over, right? We're recording this in early December. Sorry, guys, we're kind of out of time at this point. So what are things we can do before the year is over? My best advice for you, if you do have equity compensation, that's part of your compensation package or you're married to someone who has equity compensation as part of their compensation package is to do a tax projection, by which I mean grab your pay stubs, figure out how much money you've made, if you've got rental properties, if you've got other investments, and just figure out what your income is for the year and figure out if you've paid in enough tax.

3:10Because the biggest, I don't even want to call it a mistake, but the biggest trip up I see our clients make is that they've sold stock. They've made some money. That's great. We've recognize some gains. That's fantastic. They've paid some tax on it, but they haven't paid enough tax because they have more income than they think. So my biggest advice is get a tax projection done. Even if you have RSUs, which is kind of like our most common type of equity compensation, meaning you're at a public company, you've got some shares vesting quarterly or monthly if they want to make you crazy. They're probably withholding some tax on that.

3:41But if you're in a state like York or California, those are the two ones we see the most with the worst tax surprises. but we often see that you're actually not withholding enough tax on your regular investing shares. So even if you think you're doing everything right, you filled all the paperwork, you checked all the right boxes, you could still be under withheld. Our clients in New York City, we see folks at the federal level being under withheld by almost 20 % sometimes, which if you've sold six figures or even seven figures of stock, that's going to be a pretty nasty tax surprise. So as we approach year end, just know where you're at.

4:16And once we have that information, Once we know what our taxable income is going to be and how much we've actually withheld versus how much we might owe, then we can start to do some real planning. We can think about are there charitable gifts we want to make? We can get really creative with charitable gifts and equity compensation. Are there additional contributions we can make to retirement accounts? Again, probably a little late in the year for that. Are we doing 529 plans for our kids to go to college or our nieces and nephews to go to college or ourselves to go to college? So anything we can kind of do in the tax space is what I'm going to recommend right now before the year closes.

4:50Yeah, we're definitely in tax projection season. I'm more investment focused within Plain Corp's practice, but I certainly sit in meetings where people are going through tax projections. And it's not like you can magically erase the tax liability. But I'm always surprised at the shock I see in people's eyes when we talk about accelerating income in a low income year or deferring it into future years or just generally eliminating surprises. And as you pointed out, people paying penalties simply because they didn't know what they've paid in or what they haven't paid in. It's just such low hanging fruit.

5:21You definitely should be asking your advisor for a tax projection. And with stock compensation, it gets complicated. And I think you would probably agree with me that it shouldn't be so much of a one year thing as much as it should be a multi year thing. How do you think about that when you're working with clients? Absolutely. Yeah, it's certainly multi year. Very rarely do I see someone be able to exit a company in a year. In fact, when we see folks getting granted stock, there's often a one-year cliff, meaning they start working at a company and they don't actually even receive any of that stock as compensation until the 366th day of their employment, right?

5:56We call that a cliff. That's fun. It's like jumping off a cliff. If you jump off this cliff, you might find a couple million dollars of compensation. That's cool. So the way we approach equity compensation planning is a multi-year strategy. And the first question I always ask my clients, I know the right answer, but I'm always curious to hear what they say, which is how much of this company do you want to hold long term? If you had a million dollars of cash sitting on the sidelines, would you invest it all in this company? I realize that's two questions. Those are the first two questions I ask them.

6:26So that gives us a baseline, right? It gives us a baseline of what are the goals of this client? Do they really believe in the future of this company? Are they in it for the long run? Are they an executive? where their compensation and their performance is actually going to be tied. I mean, the stock price performance, is that going to be tied to their compensation? How invested in this company should they be is a good question. And if you're not at that high level, you're not at that executive level and you're a kind of rank and file employee, but you believe in the future of the company, you maybe have some inside information that you think is an advantage to everyone else who might not have that.

6:59I also want you to think about how much of this do you want to hold long term. And usually you get this big grant when you first get hired. Do you want to hold 20 % of that long term? I hope your company is the next Apple. I hope that for you. Usually with companies going public these days, it takes a long time. And unfortunately, most companies' stock prices don't do that well. They're not the next Apple. They're not the next Google to Amazon. Fill in the blank here. So a lot of the clients that I'm working with are at companies that either have recently gone public or are about to go public.

7:28So we have to have this really serious conversation about diversification. How much of your net worth do you want tied up in this one asset? It's a pretty big gamble to take. Not only is it your income that you're probably using to provide for your family, but it's also you are taking much more risk than you probably need to. So our approach when we're thinking about multi-year planning is how quickly can we diversify out of this, what we call a concentrated position? How quickly can we do that with taxes is in mind and what the client's specific goals in mind. Also with equity compensation, we have all these crazy rules, which we don't really have to get into, but there's all these requirements about holding periods, just like a regular stock.

8:08If you buy a stock and you hold it for more than a year, you get better tax treatment. So we kind of have the same thing with certain types of equity compensation. So when I'm thinking about new client walks in the door and they've got some equity and they've got some restricted stock units, some RSUs, they've got some stock options also. We're not just looking at what are we doing this week or this month or this year. We're looking at what is the five-year plan for us to have you be in a position where you've extracted some wealth. That's the most important thing. Hopefully paid fewer taxes than you would have if you didn't work with a firm like ours.

8:38That's always our goal, right? Reduce taxes in any way we can. And also, I don't want this stock price to ruin your life, to take over your life. And this is a big threat that we see, which is, Peter, you work with lots of investors. Investing money in the stock market, it's hard, right? It goes up, it goes down. It can be a bit of a roller coaster. I'm sure you give your clients this advice, like don't look at your portfolio every day. Don't do it. It would be better if you don't. It would be better if you just never looked at it for 30 years and then be happy with the results, right? 100%. Don't you wish you could say that to all your clients?

9:06That would be the dream. Unfortunately, when so much of your net worth as a holder of equity compensation is tied up in one company, how could you not check the stock price every day, right? And I bet the people you work with are talking about the stock price. You're in meetings. And like I said, maybe your literal compensation is tied to that performance of that stock price. You're thinking about it all the time. I have had clients lose their minds basically over this is so stressful. I'm going to have a hard time. I can't have this. I'm working hard and I don't want one day to wake up and look at my portfolio.

9:37And I can buy that$3 million house. And the next day we got to file for bankruptcy because that stock is worthless. So my goal is always to reduce kind of that roller coaster of equity compensation, if I can. I wrote down something you just said, don't let that stock price ruin your life. And it's perfect because a lot of times, I will admit, I think of people ruining their life from like a net worth statement perspective, just the likelihood of any individual stock experiencing a catastrophic loss is probably higher than most people realize. But kind of digging deeper as you touch on ruining your life where you're thinking about your company's stock price all the time and how distracting that can be.

10:18I do some financial wellness work with a company called Bright Plan, where I'm also the chief investment officer. And a lot of what we see, just how stress impacts your own productivity, your own mental health. And so this multi-year planning, I love that you take that approach where number one, you want to extract wealth. And yes, we're trying to minimize taxes. We're probably trying to spread across tax impacts that you can maybe avoid a certain tax bracket over a couple of years. But then the other thing you said that stuck out to me that I don't think it's explored enough, one on my show or anywhere else, is you mentioned working with people pre IPO at private companies.

10:54Let's kind of pull on that string a little bit. What do you feel like are the key considerations when deciding whether to exercise stock options when you're at a private company that maybe people haven't thought of before? Yes, I love this question. So just to talk about myself for a little bit and how I wound up in this weird position of being one of the country's experts in equity compensation, which is so wild to me because if we had met 10 years ago, you would have found me interviewing bands and going to shows and writing album reviews. So I was a music journalist and I wrote books and I edited books.

11:25So that was my previous career before I found myself here running a wealth management firm. Life is twisty and turny. So here we are. But actually, the first time I learned about equity compensation was because I worked at a music tech company and I was running their online music magazine. And part of my compensation was incentive stock options. So that was really my first kind of foray into personal finance in general. I didn't even know what a Roth IRA was at that point. And someone handed me a stock option agreement. And I was like, well, I have no idea what this is. So I'm just going to file this in the drawer and worry about that later.

11:57So I have very firsthand experience in what does it mean to be granted equity? What does it mean to not understand it at all? And I actually ended up having a liquidity event from that music tech company. They went through an acquisition. I ended up exercising my stock options when I left the company. So to me, at the baseline, when is the best time to exercise your options? Well, don't lose them. So if you're going to leave the job, whether because you're fired or you're laid off or you get a better job or you retire and you self-select out of leaving this company, that is a no-brainer, like let's stop and make sure we exercise these options before we leave.

12:36Typically, you have 90 days to do that from your date of separation. Sometimes you can extend it. 90 days goes by real quickly, folks. So if you're thinking about leaving your company and you want to exercise those options, start thinking about it ahead of time. I have never seen it go very smoothly when someone wants to leave a company and exercise options. It just takes a long time. So that's the obvious answer. When do you exercise? When you're leaving the company. In a perfect world, if I could create the perfect equity timeline, But we do have clients like this where, and these are clients who have had seven, eight figure exits even before these companies go public, which is wild.

13:10This is when you're hired early days of the company. You're one of the first couple employees. You're probably granted incentive stock options or ISOs. They're just treated differently than other stock options. I don't want to get into the details, but they can be very valuable because if you play your cards right and you time it perfectly, you actually won't pay any income tax on them at all, which is pretty cool. So ideally, you get hired early on, or maybe you're the founder and you have incentive stock options. You exercise those options, meaning you buy them as soon as you get them or within a year or whenever you're able to do that.

13:42Maybe your company offers an early exercise. So if you just got hired at a new company that's still private, you might want to ask them if early exercise is available. That can be very valuable. So you exercise your options and your grant price, your strike price, the price you're going to pay to exercise is going to be equal to what that stock is worth. That's what we want. That's the moment where we're not paying any tax on it. So if you can do that and your options cost, if you're early on, less than a penny or less than a dollar, you're only paying a couple thousand dollars to own a significant portion of that company that hopefully will just keep going up and up.

14:17So the way we see these large, life-changing lottery ticket payouts is early exercise of incentive stock options, wait it out. Company's about to go public. Other investors want to get in. They want to buy those shares from you. Now the shares are worth four or five, maybe$70, which we've seen before. Thank you, Datadog. We love you so much. When that happens, that's when you're going to see this massive gain. And you're only paying capital gains tax on that. And if you played your cards right and you held those shares for five years, you potentially have qualified small business stock or QSBS.

14:53And you potentially are not paying any tax on the first 10 million of gain there. So that's really like how to game the system. And I remember like learning about all these theories and being like, whoa, that's really cool. And then when I saw it for the first time, I was like, oh, okay, I like this part of the tax code. Like, I'm down with this. I mean, I'll tell you from personal experience, I have ISOs in a private company. And you use the word lottery ticket, which seems like a good comparison, because there's no guarantee that the company will go public or that it will exit. Look, what you're talking about is an incredible deal.

15:27The cost of it is literally the cost of exercising those options, and maybe them not being worth anything. Let me ask you this. I mean, is there a point in time where you look at someone's financial plan or their net worth statement and you say, hey, this risk isn't really worth it. If it pays off, you'll just be happy and it's a cherry on top versus, no, you should spend this money. It is a good bet if you're feeling confident that your company is going to be worth something. Yeah, absolutely. And I do believe there is such a thing as taking on too much risk. Like I said, we don't want to over concentrate in this one private or public company.

16:01Public is less risky to me because there is a public market. So worst case, you could always sell your shares to the public market, whereas private, there are often so many restrictions that you actually cannot sell your shares. There literally is no market for them. Maybe the company has put restrictions. Maybe if you have like a weird bad breakup with your company, they will maliciously restrict you in selling your shares, which we've seen before. So yes, there is such thing as too much risk. Often what I see is people coming to me, clients and just friends or people who know that I love this stuff and will happily talk to anyone about it at any time because I'm a nerd, they'll come to me and say, it'll cost me$20 ,000 to exercise my options.

16:38I like this company, but I don't know. The leadership is kind of wacky. And I got this better job. I'm leaving, so I have 90 days to decide what should I do. We're financial planners. We like rules of thumb. So a good rule of thumb, if it's more than 10 % of your balance sheet, your liquid net worth, probably too risky. Unless you're already financially independent, then great. We love risk. That's the beauty of financial independence. I named my company Brooklyn FI. The FI stands for financial independence, once you have that, you have this freedom to make riskier decisions that have less impactful consequences.

17:09So yeah, if you're financially independent, go ahead, take that risk. If it's going to prevent you from doing the upgrade on your house that you need, or getting that second car that you need, or sending your kid to college, taking that bet is probably too risky. And every investor is different. Certain people have different risk profiles. So I have certainly tried to convince a client before saying, I think this is too risky, and I've been overridden and that's fine. Like we had the conversation. I documented it, of course, just to make sure. And look, I always tell clients, especially with equity compensation, I hope I'm wrong.

17:39I always hope I'm wrong because I'm gonna encourage clients to take a little bit of risk off the table. I hope that your company is the next Apple. And I hope that you're exercising at$5 and spending half of your net worth to do this. And I hope in three years, you are a decamillionaire. I really hope that for you. However, I'm often right. And often that stock is gonna take a long time to recover and your life goals are not going to align with how the stock price is moving. Great example, we have one of our earliest, nearest and dearest clients, early employee at Spotify. Spotify stock price has been all over the place.

18:12Right now it's trading at almost$500, but three years ago it was below$100 a share. Client had a bunch of kids, needed to do a renovation on their house, needed cash. We needed cash at that moment. So we ended up selling some Spotify stock. And I guarantee you that person, I haven't heard this directly, but I'm sure it's the case, is going, why did I sell at$100 when I could have sold at$500? But they did the home renovation. The kids had their beautiful backyard. All's well that ends well. We always try to create, I like this, a scenario of least regret. Like, did we do enough? Did we take enough risk so that we could potentially have that lottery outcome?

18:48Or did we sit on our hands and do nothing, which is kind of the worst thing we can do? Just before we leave this topic, thinking about exercising your options when you're leaving a company. You don't have to do it all, remember, right? You don't have to do the full amount that's available to you. I like setting just a dollar amount. What is comfortable for you? Is it$5 ,000? Is it$10 ,000? Is it$50 ,000? Great. Let's do a tax projection because there might be some taxes associated with that exercise. But let's just come up with our budget. So at least you know you did something and you feel good about that.

19:15And you can have that lottery ticket kind of sitting in your drawer. And that's probably true whether you're leaving a company or staying, right? Absolutely. Yeah, I think the urgency, it's like leaving a company or even like getting a job offer from another company, like forces you to make decisions. Another thing that's wild about equity compensation is that if you are at a public company and you're consistently getting granted, you have to make a decision every quarter. You have to make a big financial decision literally every quarter. I don't know about you, Peter, but like I get decision fatigue, like choosing what I'm having for dinner.

19:45And these are people who have to decide like, am I comfortable selling this stock at$50 or what have you? So one way around that, that we found is really helpful is to create a trading plan. And basically, we write up a document and we say, these are the number of shares I want to sell. This is the floor price I'm comfortable with. This is how many I'm going to sell each quarter. That's kind of like how we do our multi-year kind of strategic planning where we're looking at taxes and the rest of the net worth as well. Is there anything else you mentioned when somebody's leaving a company? Is there anything else people ought to be keeping in mind as it pertains to their equity compensation when they depart or they're thinking about departing?

20:18Make friends with the accounting and HR teams because you're going to need them when the company goes public because you will be looking for documents and you will need assistance. And I say that in jest, but actually that is to me the biggest threat with equity compensation is like admin of these companies that flip from private to public. Hey, I need to exercise my shares on this date because I like the price because the fair market value, what we call the 49A is going up next week. I need to exercise this week. Oh, someone's out of the office, yada, yada, yada. Like call your girl in HR and she will help you with that exercise.

20:52That's great advice. Yeah. What else when you're leaving? I mean, yeah, just be aware of those time restrictions, 90 days. If it's a smaller company and it's still private, you probably have a little bit more negotiating power than you think. I've had folks at companies that are sub-50 employees. You can actually ask and you can say, hey, is it possible to convert this option grant into non-qualified options? So they were incentive stock options. Now they're going to become non-qualified options. You will actually have up to 10 years to then exercise those shares. So that 90 days becomes irrelevant.

21:24They convert to this other type of equity. But you can actually ask for that. I've actually seen companies rewrite their option plan agreements. I've actually helped them rewrite them to allow for this because it's a great benefit to employees. It's an accounting headache for the company to have all this equity out there that may or may not be exercised at any point. But that's a great kind of thing to ask for if they're amenable to it. Now, you had mentioned a client you worked with at Spotify, which is ironic because there's somebody I have in mind that I have worked with from Spotify and the price was soaring during the pandemic and they were acquiring podcasts.

21:58And then it plummeted when interest rates started to go up. And I remember that person saying, gosh, if it would ever get up to 270, I would sell all of it. And now here we are well past that point. Yeah, we're looking at 500. Right, exactly. And I think it's an important narrative for those of you listening with individual stock. We say this not in jest or in making fun of anybody, but it is a really emotional ride. And I think there are times, at least in Spotify's case, people are getting an opportunity to exercise with an appreciated price. But how do you think about exercising options during a period where the share price is a bit depressed?

22:34I'm so glad you asked because yes, we've seen this with Spotify. Spotify is also unique because they have a very tight exercise window. So typically when we see stock option grants, you have 10 years to exercise from the date that it's granted to you. Spotify is five. They also have a very flexible equity menu, if you will, sort of like we call it a choose your own adventure. They let you pick what you want. You can do cash, you can do RSUs, you can do options, which I'd like to think is well intentioned. I believe it is well intentioned, but it also just, again, creates a choice for every Spotify employee.