Millennials in startups face taxation of stock options questions

July 11, 2018 : Annelise Wiens

The economy gained five times as many jobs in 2017 from startup companies compared to older firms in 2017. While it’s becoming more common to start working for startups, millennials still early in their careers might be surprised to encounter complex compensation packages thought to be reserved for more seasoned professionals, like stock options.

“When thinking of startups, stock options or other methods of deferred compensation, allow companies that might not have the cash laying around to pay employees’ wages,” said Mike Slack, lead tax research analyst with The Tax Institute at H&R Block.

For millennials, the youngest of whom are hitting the traditional age for graduating college, getting jobs at startups where the compensation package includes nontraditional benefits, it’s important to weigh the overall value against the tax impact.

Stock options tax for beginners

If a company offers stock options with compensation packages, the employee will receive the stock with restrictions about when they can sell it. The employee will not be taxed on any income related to the stock until it vests, or until the restrictions are lifted. Then, the employee will have to include the fair market value of the stock in their wages and pay income taxes on that amount.

“The incentive for the employer is that you keep the employee around when you might not have enough money to pay them what they’re worth. The incentive or bet for the employee is that the company will be profitable and the stock will be worth far more at the vesting date that it was when it was granted,” said Slack.

If the value has grown like the employee hoped, the employee will pay taxes on the greater value. It’s the fair market value on the date it vests, so a windfall could set off a domino effect with higher tax rates and the loss of some tax benefits that phase out as income rises.

If the value of the stock tanks, there’s no tax benefit for a personal loss.

Some plans, though, allow the employee to choose to include the fair market value of the stock in wages on the date it is issued instead of when it vests. In this case, were the stock price to later rise, the employee would be taxed only on the gain in the stock’s value when they sell it, if certain conditions are met, as they have already paid tax on the stock itself when the option was granted.

The employee can lower the tax rate on the stock’s gain by waiting until it qualifies for the capital gains tax rate, which is generally lower than the ordinary income tax rates. The stock will qualify for capital gains treatment when the employee has held it for at least two years from when it was granted and one year from when it was purchased.

Slack advises that tax planning is best done over a multi-year timeframe, because what’s good in one year might lead to a bad tax outcome the next year.

For help understanding the tax impact of a specific job offer, taxpayers should ask a tax professional.

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Annelise Wiens

Former Editor and Producer

As the former newsroom editor, Annelise Wiens was interested in more than just tax and industry news, but the stories of H&R Block's 80,000 associates, their communities and H&R Block's world headquarters in Kansas City, Mo. Wiens joined H&R Block in 2014 from a public relations agency, where she worked with clients in the financial services industry. Before that, she worked as a communicator for a senior member of the United States House of Representatives. She graduated from Biola University in La Mirada, CA with a bachelor's degree in history.

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