$1M payout - how do I effectively reduce tax liability and maximize proceeds

[LimaDon]

Hey fam,

With strong promise of grossing $1M in a payout shortly (startup exit proceeds), I am in need of some unbiased advice (read: non-financial planning fee consideration advice) on how to deploy these funds to reduce tax liability and maximize early retirement proceeds.

This has been what we have been slaving away at for the last 5 years, and our hope for a home run to financial independence.

If I could keep the $1M and live off our 4% rule, I'd be flying high and able to retire early off $40k/yr (yes-possible with 3 kids). However, I recognize Uncle Sam has to get theirs, and I am under the impression that this will be in the form of long-term capital gains (20%?).

Debt is paid off (minus mortgage), emergency fund is funded, and 401k match is met. I am ready to put these dollars to work for our family.

Any advice on how to reduce the tax liability would be much appreciated.

Thanks!

[Frugal D]

Congrats on a profitable exit! Something to be very proud of.

Can you give us more detail about the situation? What form is your equity in? RSUs, stock options, etc? Are you currently fully vested?

I'm not a tax guy, but there's not much you can do to (legally) prevent Uncle Same from getting his. Depending on what form your equity is in, your gains are actually going to be taxed as regular taxable income and not long term capital gains. The amount of money the government rakes from acquisitions each year is just disgusting. 

You're basically going to walk away from this netting $500-600k.

[LimaDon]

Thanks for the atta boy Frugal! It would be a great return on a long and stressful journey with a lot of sweat, sleepless nights and the like.

My company equity is fully vested (common shares) and would be paid out as cash at closing. Bummer to hear that this could be considered regular taxable income (though I thought that was on shares held less than 1 year and these have been held for multiple years). If regular, that would put us at a wild 40% tax bracket. Sickening..

[Pooplips]

Following to hear what some of the tax guys on here have to say.

[DevoCPA]

Need more detail on what the payout is. Are we talking stock options? Are these Nonqualified or ISOs?

[BlueLesPaul]

I couldn't confirm this (went to Section 1231 and Section 197 of the Internal Revenue Code), but I am sure that goodwill for your business would be tax at capital gains rate, which would be either 0%, 15% or 20%.  The sale might also be subject to the Net Investment Income Tax of 3.8%

I believe that you can do a lot to reduce your tax liability if you could structure it as a installment sale, but I know those can be complex from a tax perspective and it does not sound like it won't be an option for you.

If you have any property with allowable depreciation that is begin sold as part of the business, you may have to pay deprecation recapture if the property is sold for more of the depreciation taken out of the property.

I certainly would like to hear from someone that has more experience with these types of transactions.  I certainly would talk with a CPA or tax professional to see what your options are.

[Reynold]

  I certainly would talk with a CPA or tax professional to see what your options are.

In fact I would talk to more than one, for something complex like this.  Get a company bonus of $1M as part of your paycheck and it is pretty straightforward, welcome to a high tax bracket that year, but something like this could depend a lot on what types of shares you had, how the sale is structured, etc.  Ask at least a couple of accountants if they have experience with this type of transaction specifically, ideally they have done more than one.  If it isn't too late, they may even be able to give advice on how to structure the transaction to help. 

[spud1987]

I'm a tax lawyer but I caveat my summary below by saying this post is neither tax nor legal advice and you should consult an advisor.

The taxation will depend on the type payout you receive. Employees are often awarded RSUs (restricted stock units). These are taxable when received (i.e. vested). They are typically taxed at ordinary income rates and subject to supplemental wage withholding (i.e. the higher withholding calculation that accompanies bonuses). If you don't sell the RSUs, you are then taxed on the appreciation over when you received the RSUs at capital gains rates (either short or long term).

So if you receive $1M market value in RSUs and sell them immediately, you will have an extra $1M in ordinary income and that amount will be subject to Fed, state, SSDI, etc. tax.

There is similar treatment for NSOs (nonqualified stock options) and ISOs (incentive stock options).

The bottom line is that it is difficult/impossible to avoid ordinary income taxation upon becoming vested. Still not a bad problem to have! Congrats!

[2Birds1Stone]

I have nothing of value to add other than a pat on the back.

Congratulations!

[Wile E. Coyote]

Thanks for the atta boy Frugal! It would be a great return on a long and stressful journey with a lot of sweat, sleepless nights and the like.

My company equity is fully vested (common shares) and would be paid out as cash at closing. Bummer to hear that this could be considered regular taxable income (though I thought that was on shares held less than 1 year and these have been held for multiple years). If regular, that would put us at a wild 40% tax bracket. Sickening..

If you were taxed on the value of the shares when they were granted or vested at ordinary income rates, then provides that you have held them for a year, you should be able to recognize capital gains on the sale of the shares.

[LimaDon]

Thank you all for the advice! I am going to check in with our CPA and local counsel and let everyone know how it turns out and if there's any learnings I can share!

[Gin1984]

Side note, you said you "401k match is met", an easy way to shelter at least some of the money is to max out your 401k, not just meet the match.

[bacchi]

Thanks for the atta boy Frugal! It would be a great return on a long and stressful journey with a lot of sweat, sleepless nights and the like.

My company equity is fully vested (common shares) and would be paid out as cash at closing. Bummer to hear that this could be considered regular taxable income (though I thought that was on shares held less than 1 year and these have been held for multiple years). If regular, that would put us at a wild 40% tax bracket. Sickening..

If you were taxed on the value of the shares when they were granted or vested at ordinary income rates, then provides that you have held them for a year, you should be able to recognize capital gains on the sale of the shares.

It's 2 years from grant and 1 year from exercise for ISOs. If those dates aren't met, it's split between earned income and cap gains.

Yeah, it's complicated. Definitely talk with a CPA or two.

[MrFrugalChicago]

I'm a tax lawyer but I caveat my summary below by saying this post is neither tax nor legal advice and you should consult an advisor.

The taxation will depend on the type payout you receive. Employees are often awarded RSUs (restricted stock units). These are taxable when received (i.e. vested). They are typically taxed at ordinary income rates and subject to supplemental wage withholding (i.e. the higher withholding calculation that accompanies bonuses). If you don't sell the RSUs, you are then taxed on the appreciation over when you received the RSUs at capital gains rates (either short or long term).

So if you receive $1M market value in RSUs and sell them immediately, you will have an extra $1M in ordinary income and that amount will be subject to Fed, state, SSDI, etc. tax.

There is similar treatment for NSOs (nonqualified stock options) and ISOs (incentive stock options).

The bottom line is that it is difficult/impossible to avoid ordinary income taxation upon becoming vested. Still not a bad problem to have! Congrats!

Many corner cases, right?  Like if he was given the stock years ago and did 83B, he may very well ONLY owe capital gains tax (he paid the income side of the tax years ago when he filed 83B). Seems 83B is fairly rare to do though....

[MrGreen]

I'm not sure if this strategy will work for the sale of equities but I'll outline it since I'm pursuing it as an option for a property sale what will net me a similar seven figure payout. It's called a structured sale annuity, some times referred to as simply a structured sale. It is essentially an installment sale but it differs a little in that the purchaser doesn't pay you over a period of years. The purchaser pays the entire amount at the time of the sale. You choose to receive as much as you want at the time of sale (and pay taxes accordingly) and the rest is paid to a 3rd party, an assignment company, who in turn purchases a annuity from a highly rated life insurance company at the terms you specify. The life insurance company will provide a yearly payment based on the going rate for annuities with the terms you're looking for.

The IRS has ruled that because the assignment company purchased the annuity, with you as the beneficiary, you do not actually "earn" the income until the money is paid to you. So every year you would have some taxable income. This is particularly appealing to someone looking to retire because if your yearly payments are small enough that it keeps you in all the 0% tax brackets (not as valuable if all your income is ordinary income since the threshold for paying no tax is much lower than long term capital gains) then you pay no Federal tax. You'll still pay state tax but there could be substantial savings to be had.

I did the rough math on how a 30-year payout of a seven figure annuity compares to taking the seven figures immediately, with the log term capital gains hit, and investing it and the return is about the same due to the tax savings. So if you had other money invested and wanted a diversification from owning nothing but index funds or other equities, this option could be appealing. This option probably would not be appealing if you planned to continue earning income since that would kick you into higher tax brackets every year you have the annuity income.

Again, I'm not sure if you can do something like this with a sale of stocks or options but I'm just throwing it out there as something you might want to investigate.

[Cyaphas]

"Move" to a no income tax state before receiving the bonus.

[tonysemail]

thanks for posting your strategy mr. green.
It's pretty interesting, so I will probably research it some more using google.
do you have any links to articles or calculators which you used in evaluating your case?

Also, how do structured sale annuities work with respect to primary homes?
Does the use of structured sale disqualify the homeowner from the 250k/500k homeowner's exemption?

[tonysemail]

looked up the answer and you're allowed to take the homeowner's exemption.
it also states pretty clearly that you can't use this strategy with publicly traded stock.
https://www.irs.gov/publications/p537/ar02.html

[Wile E. Coyote]

Thanks for the atta boy Frugal! It would be a great return on a long and stressful journey with a lot of sweat, sleepless nights and the like.

My company equity is fully vested (common shares) and would be paid out as cash at closing. Bummer to hear that this could be considered regular taxable income (though I thought that was on shares held less than 1 year and these have been held for multiple years). If regular, that would put us at a wild 40% tax bracket. Sickening..

If you were taxed on the value of the shares when they were granted or vested at ordinary income rates, then provides that you have held them for a year, you should be able to recognize capital gains on the sale of the shares.

It's 2 years from grant and 1 year from exercise for ISOs. If those dates aren't met, it's split between earned income and cap gains.

Yeah, it's complicated. Definitely talk with a CPA or two.

OP refers to vested shares, not options.