Getting the news that your startup is going public means the excitement is real, and so is the “what do I actually do now” feeling when the equity paperwork lands on your desk. Turning stock options into cash without giving away half of it to taxes takes a plan, and the plan starts with understanding how your specific equity gets taxed.
Ordinary Income vs. Capital Gains, and Why the Gap Matters
Money from selling stock gets taxed one of two ways: as ordinary income, at the same rate as your salary, or as long-term capital gains, which run at roughly half the rate. To qualify for long-term treatment, you need to hold the stock more than a year after acquiring it. If you’re in the 32% ordinary income bracket, your long-term gains might land closer to 15%. On a meaningful equity payout, that difference is real money, which is why timing decisions deserve more attention than most employees give them.
ISOs, NSOs, and RSUs: Three Different Tax Pictures
Most companies grant a mix of incentive stock options (ISOs) and non-qualified stock options (NSOs), and they’re taxed differently. With NSOs, exercising triggers ordinary income tax on the spread between your strike price and the current 409A valuation; when you later sell, any additional gain is taxed as capital gains. ISOs are more complicated: you don’t owe tax at exercise, but you may trigger the Alternative Minimum Tax. AMT exposure kicks in once your bargain element, the spread between strike price and 409A value, crosses roughly $76,000 for single filers, and the AMT rate on that amount runs 26% to 28%. The upside is that you can often recover AMT paid in prior years as a credit in future years when you don’t owe AMT. If you hold ISO shares at least a year past exercise and two years past the grant date, the full gain qualifies for long-term capital gains treatment when you sell.
Restricted stock units are simpler. RSUs convert to shares at vesting, and you owe ordinary income tax on their value at that moment. Many companies use double-trigger vesting, meaning RSUs don’t actually vest until the IPO happens, which is useful because it lets you sell some shares immediately to cover the tax bill. Any gain beyond the vesting-day value, when you eventually sell, is taxed as a capital gain.
Qualified Small Business Stock: The Provision Worth Checking
Qualified Small Business Stock (QSBS) treatment can eliminate federal tax entirely on up to $10 million in gains. Your stock may qualify if the company had less than $50 million in assets at the time you exercised your options and you hold the resulting stock at least five years. It’s worth having a tax professional check this before you sell anything, since the eligibility rules are specific and the payoff for qualifying is large.
Deciding When to Sell
Once the lockup period ends, typically around six months after the IPO, you’ll face the actual sell decision. Employees generally land in one of a few camps: selling most of their equity right at lockup expiration to lock in gains and cut risk; waiting for long-term capital gains treatment before selling; selling a fixed amount on a quarterly schedule regardless of price, which removes emotion from the decision; or holding most shares for years on continued conviction in the company. None of these is automatically correct. The right approach depends on how much of your net worth is tied up in the stock, how diversified the rest of your portfolio is, and your own read on the company’s prospects, not just its post-IPO headlines.
Reducing the Tax Bill Once You’ve Sold
A handful of strategies come up often once employees are staring down a large tax bill from a sale. Donor advised funds let you take an immediate deduction for a charitable contribution while distributing the actual funds to charities over time. Tax loss harvesting, selling other positions that are down to offset gains, can reduce the total bill. Some employees relocate to a state without income tax, which only works if you establish genuine residency, not just a mailing address. And taking time off in a lower-income year can shift you into a lower bracket for that year’s sale.
None of this replaces working with an advisor who understands equity compensation specifically. The planning fees are usually small next to what proper timing and structuring save you, and the decisions you make in the months after an IPO tend to shape your financial position for years, not just the current tax year.
Educational only, not tax, legal, or investment advice. Check primary sources and speak with a qualified professional before making financial decisions.
