46

I had stock options in a company which was recently sold to a private investment firm. As a result, my options were converted into a single large sum ( > $100,000) and delivered via wire transfer into my banking account.

This is a staggering amount of money for me. I have no debt outside my mortgage, so the plan was to just roll this in with the rest of my investments.

That said, I would be flabbergasted if there wasn't some tax thing I needed to do to account for this influx of cash. I did get an explanatory letter from the company's CFO which noted that the proceeds from the sale may qualify as long-term capital gains (I received the stock options > 2 years ago).

Feeling a little overwhelmed -- what next?

Follow Up:

I have spoken with a CPA, and have learned a few things:

  • I did not have stock options, I had actual stock, so there was no need to exercise.
  • As long as I withhold 110% of my previous year's tax burden, safe harbor laws mean I won't be penalized for not paying estimated taxes.
  • In my case, this does qualify as long-term captial gains.

Speaking to a tax professional was the correct play.

  • 55
    I would expect that it would be well worth the cost to assume that you'll want to have an accountant prepare your taxes this year and to book an appointment with one now to do some tax planning/ estimation. It's likely relatively easy to get an appointment at this time of the year since it's well after tax season and the peace of mind would likely be worth it. – Justin Cave Jun 10 at 16:16
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    Exercise means you actually paid the option price to receive stock. This sounds more like you received a cash payment in exchange for any vested (but unexercised) options. – chepner Jun 10 at 18:02
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    No, exercise means you converted the option to a real share. Especially when you sell them immediately, you can often do a cashless exercise, where the exercise, sale, and then issuance a check, all happening as an atomic operation without you paying money directly. Sounds like that's what the OP did. – stannius Jun 10 at 19:05
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    What exactly was done to convert your options into cash? The details matter for the tax treatment. Among multiple possible ways that it might have been done: A) The options vesting was accelerated. You were given the options, both earlier (potentially at multiple times) and now, then you were paid a lump sum for the actual options. B) You were paid a lump sum to give up the vested options and options which had not vested. C) Similar to (A), but the options were converted into stock and the stock sold, with you recieving the difference from the option price to current. D) Something else. – Makyen Jun 11 at 0:42
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    The country/state etc. may be important to know here. Is this in Australia, France, USA in Rode Island? Otherwise simply consult a tax an accounting professional is really all we can say here. – Mark Schultheiss Jun 11 at 11:16
38

In this case you should consult an actual tax professional since that can be rather complicated.

In general

  1. Tax treatment depends on whether (and how long) you did own actual stock at any point or if your options were directly converted to cash in a "same day sale".
  2. Assuming it's a "Same day sale" then the profit (sell price - exercise price) is taxable as "ordinary income". Same as your paycheck.
  3. You will need to pay "estimated taxes" this quarter to avoid an "underpayment penalty" next April
  4. You may want to check your withholding or estimated tax for previous quarters. If the windfall triggers certain "phase out" provisions you may be subject to underpayment penalty. However, with the new Trump tax laws that is very unlikely.
  5. You may want to adjust your withholding for the rest of the year to make sure you don't underpay in these quarters either.

You can certainly calculate all this yourself, but in this case, having a pro do it may easily save you more money then you need to pay for the service and you are on the safe side.

If you did own actual stock (not just options), things are significantly more complicated.

EDIT: rephrased bullet 4 since it was poorly worded

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    @chepner As long as you withhold at least 110% of your previous years tax liability, you will not be hit with any penalty for underwithholding. – stannius Jun 10 at 18:43
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    @Hilmar "Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller. " From irs.gov/businesses/small-businesses-self-employed/… , emphasis mine. – stannius Jun 11 at 13:41
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    @Hilmar the exceptions are things like farmers, fishermen, aliens, higher income people (hence 110% in my previous comment vs. 100% in the text I quoted), and people whose prior year tax return didn't cover the whole year. Since you mentioned quarters, you must be someone who pays quarterly estimated taxes; such things are subject to both amount and timing calculations. Taxes withheld via W-4 paycheck withholding are always considered to have been withheld timely. Therefore, anyone who has 110% of their prior full year total tax withheld by paycheck withholding is safe from penalty. – stannius Jun 11 at 17:24
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    Your #4 implies a gross misunderstanding about how marginal tax rates work. – xyious Jun 11 at 18:11
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    "there is no way the IRS will let him get away with severely underpaying just because last years income & taxes were much lower" Except the tax code provides exactly this safe harbor. – Andrew Lazarus Jun 11 at 19:35
16

In addition to other answers: this might be a good year to change your 401k, IRA and HSA contributions to IRS-allowed maximum. To make sure that some part your income goes into tax-protected accounts.

  • 4
    absolutely this. If you weren't putting any money into IRA or 401k before, and you maxed them out right now (as a single person), that removes $25k from your tax equation this year, saving you about $6000. If you are married, that is $31k removed, and $6820 saved. If you qualify for an HSA, those numbers all go up a bit. (It also changes a bit based on your regular income) – BlackThorn Jun 11 at 16:32
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    @BlackThorn OP just made $100k on top of salary, so he's well over the threshold to be able to deduct IRA contributions if he also has access to a 401(k). – stannius Jun 11 at 17:42
  • @stannius not sure what part of my comment you were replying to. I said he should be able to do both 401k and IRA. – BlackThorn Jun 11 at 18:05
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    @BlackThorn The part where you say it will remove $25k from his tax equation. OP is allowed to max both a 401(k) and a traditional IRA, but he won't be able to deduct the IRA contribution, so he'll only lower his taxable income $19k. (Exceptions: over 50, married to a spouse who does not participate in a 401k). – stannius Jun 11 at 18:09
  • And since he canot deduct the trad IRA, it is a non-deductible IRA he can trivially roll over into a Roth without penalty (now that a leak has confirmed the validity of the Roth backdoor). – Harper Jun 12 at 20:01
8

Yes find a tax professional to provide an estimate of how the windfall will impact your taxes. They will know if it is short-term or long term capital gains.

What I want to talk about is the topic of quarterly taxes.

Those are not a concern for you this year. Many of the answers are telling you to make sure that you pay the quarterly taxes and even implying that of the windfall is high enough it could impact previous quarters. Nonsense.

Your situation is the perfect situation for taking advantage of the safe harbor for withholding. You just have to make sure that the withholding from your regular job meets the safe harbor level.

From IRS PUB 505 (2019):

General Rule

In most cases, you must pay estimated tax for 2019 if both of the following apply.

  1. You expect to owe at least $1,000 in tax for 2019, after subtracting your withholding and refundable credits.

  2. You expect your withholding and refundable credits to be less than the smaller of:

    a. 90% of the tax to be shown on your 2019 tax return, or

    b. 100% of the tax shown on your 2018 tax return. Your 2018 tax return must cover all 12 months.

Note. The percentages in (2a) or (2b) just listed may be different if you are a farmer, fisherman, or higher income taxpayer. See Special Rules , later.

Regarding higher income:

Higher Income Taxpayers

If your AGI for 2018 was more than $150,000 ($75,000 if your filing status for 2019 is married filing a separate return), substitute 110% for 100% in (2b) under General Rule , later.

For 2018, AGI is the amount shown on Form 1040, line 7.

You may need to modify your W-4 allowances to make sure that you have 100% of your taxes for the previous year withheld, but making that safe harbor specified in 2B above will allow you to legally delay paying the bulk of the extra taxes owed until the spring of 2020.

I have used this safe harbor provision several times.

  • Note that this is only for federal taxes; the safe harbor conditions for state taxes might be different. Depending on your state and other conditions, withholding 110% of last year's tax obligation might not be enough to avoid an underpayment penalty. – user102008 Jun 11 at 18:51
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    @user102008 True. Also, some states that have no income tax on normal wage/salary income do have an income tax on capital gains, at least above a certain amount (my state, TN, is one of these,) so you might owe state income taxes even if you normally don't. These are all things that a local accountant will be able to work out for you. – reirab Jun 12 at 19:51
7

"my options were converted into a single large sum"

You are probably leaving out some important details and it is critical that you either get them correct or hire someone to do it for you. What you described is usually a two step process, and I will include some additional steps:

  1. options are granted. Usually your stock price is locked in at grant time.
  2. options vest. This means you have the right to exercise the option. Some people do not exercise as soon as the stock vests if they believe the stock will continue to appreciate in value and they don't need the money right away.
  3. vested options are exercised and turned into stock. Depending on the type of option you have, this may or may not be a taxable event. What matters is whether your options were ISO or NSO.
  4. stock is sold and turned into money. This is always a taxable event but the time interval between exercise and sale affects the type and amount of tax you pay.
  5. quarterly estimated tax is owed. The IRS wants to see you keep up with your tax obligations. For most W2 taxpayers, this happens automatically with your paycheck. But events such as stock sales are your responsibility with regard to taxes.
  • 2
    In a case where the company is sold, however, what often happens is stock options are treated as being cancelled in exchange for cash with value equal to the spread of the options, in which case for tax purposes there is no exercise or sale, but rather just a cash payment. – user102008 Jun 11 at 18:47
  • I would want more details on "just a cash payment". Is it W2 income? Is it investment income? capital gains? – Philip Ngai Jun 12 at 23:53
  • If it's treated as a cash payment from your employer, it would be reported on your W-2. (Well, even if it was stock options that were exercised and immediately sold, the spread at the time of exercise and sale would also be reported on your W-2.) – user102008 Jun 13 at 0:33
5

This is going to be considered income, so sock a portion of it away for taxes!

The question then is, "how much should you sock away?"

That depends on how long you've held the options.

  • If less than a year, then it's short-term capital gains and so will be added to your income, so you'll be boosted into a higher bracket. Estimate what that will be based on your current income, and then put away that percentage of the $100K for taxes.
  • If more than a year, then it's long-term cap gains. Thus, put away 20% for taxes.

These "put away estimates" might be too high (you might have put too much in a high yield savings account), but better too much than too little.

Another issue is that you might need to pay quarterly taxes on the windfall. I'll leave it to others to answer that.

  • 1
    Quarterly taxes‽ – Sable Dreamer Jun 10 at 13:58
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    @SableDreamer irs.gov/faqs/estimated-tax/… – RonJohn Jun 10 at 14:21
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    According to the link you shared they will have to pay estimated tax on the windfall, so why leave it to others? Socking a portion away is not the answer, paying the appropriate tax now, is. – Hart CO Jun 10 at 14:57
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    I don't think this is correct. To get long term capital gains tax, you must hold the actual stock for at least a year . The age of the options doesn't matter – Hilmar Jun 10 at 17:21
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    @Hilmar the age of the options does matter, in that they also need to have been granted at least two years ago. – Kevin Jun 10 at 17:39
4

Yes. There's a big thing you've got to do!

You need to go get the document that the check came with and search it for "Withholding". You need to know if they withheld taxes for State and Federal. Commonly, on a stock option execution like this, they do a flat 25% withholding. But you need to know for sure.

Do a "dry run" on your taxes to spot big problems

And if everything I say below is "blah blah Ginger" to you, then talk to your tax advisor. If your tax advisor is TurboTax, take it to a better tax advisor.

We're not doing fine numbers here, so you can just use 2018 forms and instructions. Our goal here is to figure coarsely what your ultimate taxes will be, and see if enough money has been withheld; and if not, correct that.

I'd expect it to go pretty quick with the new Trump postcard forms, the main thing that's new is figuring out the correct tax treatment (category) for the lump sum.

Remember: Don't put the value of the check you got as income -- you have to use the "gross income" and "withholding" numbers off the paperwork that came with the check. So for instance if the check was $100,000, the gross income was $135,000 and the Fed withholding was $30,000 and state $5000, you have to use the $135,000 number on the "income" side of your 1040.

For your regular salary, use last year's if you don't expect it to change much, or if you know how much it changed by percentage, just fudge upward all the numbers: gross income, tax withheld etc. We are not after perfection today.

Finally at the bottom of this "straw 1040" you'll have "Tax." And "Taxes withheld" (both from salary and from this big cash-out). What's the difference? Will you owe money or be owed a refund?

  • If you're owed a refund, don't worry about it.
  • If you're owed a HUGE refund, ask another question about adjusting your withholding.
  • If you owe less than, say, about 5%, don't worry about it.
  • If you owe more than 5%, then whatever that difference is that we came up with in our rough draft here, you should make an estimated tax payment. You do those on Form 1040-ES.

This isn't precision work here; we're using last years' forms for Pete's sake; we only need to get in the ballpark.

If you owe enough to the Feds to justify sending a check, then you should do the same above procedure for State (or county/city) taxes, because you may owe them estimated payments also.

IRS requires that you pay your taxes throughout the year roughly when you earn them. For instance I got a huge windfall in December, and I made an estimated tax payment in December. They were satisfied by that because the income came in December. When you fail to do that, and pay a large fraction of your taxes on April 15, they have penalties for that.

Remember, in 2020 when actually filing your 2019 taxes, to include this estimated tax payment inside your "withholding and payments" area of your tax form. If you mess this up, IRS will fix it for you.

  • There was explicitly no withholding done, hence this question! – Sable Dreamer Jun 12 at 20:41
  • @SableDreamer you're sure of that? OK. Then you have to do the dry-run both state and Federal, and send in the expected amount. Horseshoes is good enough; get within about 10% you should be alright. But don't rely on that 10%, e.g. Don't use last year's forms and send in 10% less. This is all guesswork so leave margin for error. I am leaving it as-written and kinda basic, to benefit other Google searchers who may not be as sure as you. – Harper Jun 12 at 20:44
3

That said, I would be flabbergasted if there wasn't some tax thing I needed to do to account for this

The stock option agreement you signed told you that taxes are your own responsibility. These transactions are just different than wage work even though your employer happens to be involved there is no withholding obligation from them.

Your CFO was correct, it MAY be long term capital gains, as in MIGHT. It MAY be income. It depends on the kind of contract (NSO, ISO, something non-standardized), and it depends on what you did when you received them like make an 83(b) election with the IRS or an 83(i) election with the IRS, or nothing. It depends on whether this transaction that was ultimately going to convey equity ownership for you was actually an OPTION or an EQUITY grant. If it was an equity grant it depends on if it was an RSU or RSA or something non-standardized or something else. In either scenario it depends on the share price of the conversion to cash payout.

When your CFO said it "may" be long term capital gains, its because it is the most favorable outcome tax wise and other employees in your company were on top of this strategically doing all of the aforementioned elections depending on their specific preferences and goals when they got their stock options. If you were one of those people, then it is just welcome news that the CFO reassured you of. Your CFO doesn't know exactly what you did or didn't do.

0

You need to figure out how much this is going to affect your taxes. I agree with others that you need a tax professional. In the immediate term, you could probably get away with just paying $30,000 (30% of the windfall) as estimated tax. I believe that June goes in the third quarter and is due September 15th. But I think that you can be more precise and withhold less if you consult a tax professional.

In a comment, you asked

Any suggestions on how to find a tax professional in my area? Am I looking for a CPA, an EA, or something else?

A CPA (certified public accountant) is for corporations. They are state certified as professional accountants who can do the quarterly audit of your corporation. You don't mention having a corporation, so you don't really need a CPA.

An EA (enrolled agent) is IRS certified, including for individuals. This is more like what you need. But there's another aspect. Whether you are getting income or a capital gain depends on the exact contract through which you got the stock options.

The kind of person who tells you the tax implications of a contract is called a tax lawyer. You can call your local bar association and ask for a recommendation for a tax lawyer with knowledge of stocks options received by an individual. This person should be able to tell you how much additional tax you would have paid if you received the windfall last year. If you withhold that much, it should cover you for this year. The big question is if you pay tax on income or capital gains and in what bracket.

  • This seems incorrect. A CPA definitely doesn't just do corporate taxes (maybe some only do business taxes, but not all, and I'm 100% sure there are CPAs who actually focus on individual taxes). According to toptaxdefenders.com/blog/… a tax lawyer is more for when you get in trouble / an argument with the IRS, regardless of whether it is individual or corporate. – stannius Jun 11 at 17:48
  • @stannius A CPA can do taxes for anyone. But the actual CPA certification is only needed for corporate taxes. If your goal is individual taxes, you don't need the accountant to have a CPA. The CPA doesn't hurt anything, but for individual taxes it doesn't help either. And your link basically says to go to a tax lawyer when you need legal help (which is true here, where the precise legal difference between two contracts matters). Their example is in a dispute. And if you have no existing relationship, I agree that hiring a tax lawyer is better in a dispute. – Brythan Jun 11 at 18:37
-2

More of an idea but... Probably a slight unorthodox approach, but if you have any ambition of setting up a private company, you could technically put the money into the company. I'm sure there will still form of tax cut, just purely because it was sent to you personally, so some form of personal tax liability I would assume.

But it would be strong if you could get some return on the money, a business could be a viable option if you feel up for the learning involved etc.

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