Smart Moves to Consider with Your Equity Compensation During a Bear Market
- Lower stock prices today create opportunities for tech industry employees holding significant stock in their employer
- There are moves you can make to reduce tax liability while lowering your risk exposure
- All strategies should have the big picture in mind with a long-term outlook.
Market volatility can be a scary thing when you hold a significant amount of stock in your employer. The thought of having both your financial capital at risk and perhaps even uncertainty about where the job market may be headed might lead to anxiety. Take heart! There are actions you can make today that can actually take advantage of the current stock market dip. Moreover, ‘now’ is always a good time to review your overall financial plan so that your risks are properly managed.
Here’s the first thing you should do: Take a deep breath. Seriously. After the last few years, stress levels across all job areas, regardless of financial status, are through the roof. Spice in a bear market, inflation, and a recession, and times feel really tough. History shows that ‘this, too, shall pass,’ however. Here are four financial actions to consider with your equity-based compensation during this volatile period.
- Consider executing incentive stock options (ISOs) and non-qualified stock options (NSOs).
Saving money on taxes feels like such a win. When the price of your employer’s stock falls, there’s an opportunity to reduce your long-term tax liability. ISOs are usually not taxable at the exercise date but can generate Alternative Minimum Tax (AMT). When the stock market is down, the number of shares you can exercise before triggering AMT goes up. .. With NSOs, ordinary income tax is owed on the difference between the exercise price and fair market value (FMV) of the shares when you exercise so when the FMV is down, your tax liability to purchase the shares also goes down. Note that in both cases, with incentive stock options and non-qualified stock options, capital gains tax is owed when you sell (on the difference between the sale price and the FMV from the exercise date).
Source: Investopedia
While the tax rules might seem complicated, the Archer team is here to help you execute the best strategy. At a high level, however, lower stock prices make executing stock options more favorable from a tax standpoint.
- Reduce high concentrations of employer stock.
Many employees at startup companies and small businesses face the risk of both their equity portfolio dropping and economic troubles hitting the business itself. You can partially mitigate that risk by reducing exposure through the amount of employer stock you own. Lower share prices often present the chance to sell shares to diversify. For example, for tech-industry professionals, liquidating stock in your employer and investing the proceeds into other sectors and even geographic areas reduces your overall financial risk profile. It may feel counterintuitive to sell a stock while it’s down, but you’re also using the proceeds to buy into areas that are also down.
A bear market is generally a tax-friendly time to consider selling vested restricted stock units (RSUs), ISOs that were purchased more than a year ago, and ESPP shares that were bought in an offer period that is more than two years ago (to avoid a disqualifying disposition). If you sell at a loss, you can even capture tax-loss carryforwards—tax loss harvesting (TLH) is a strategy where you sell at a loss today to offset realized gains in other parts of your portfolio. TLH is also commonly used to take a tax deduction of up to $3,000 per year based on the amount of your realized loss. You can claim $3,000 in capital losses each year going forward if your loss exceeds that amount. Once again, selling at a lower price today is not a total loss, but an opportunity. You can avoid a major tax bill while buying into other growth areas of the market at low prices.
- Maximize your ESPP during the next purchase period.
Employee stock purchase plans (ESPPs) often feature the opportunity to buy employer shares at a discount. While this strategy must be carefully thought through and managed, purchasing when the stock is down could be a worthwhile move.
Your strategy may be to be purchasing new shares in the ESPP to take advantage of the bear market and discounted shares while also selling other lots you have held longer-term to diversify your portfolio. Be sure to hold this stock for 2 years after the offer period to avoid a disqualifying disposition.
- Private stock: Wait for a valuation adjustment if you think the value of your private company has gone down.
You may want to wait until after your private company goes through its next valuation before you sell employer stock. Many small companies, particularly in the tech industry, might be going through a valuation adjustment period right now. It is possible if you work for one of these firms that the value of your stock options and restricted stock units could see a downward change soon through a 409A valuation. According to Carta.com, a 409A valuation is an independent appraisal of the FMV of a private company’s common stock (the stock reserved mainly for founders and employees). This valuation from section 409A of the IRS’s internal revenue code determines the cost to purchase a share.1
It’s critical to think realistically about the chance of a significantly lower valuation at the next appraisal. Here’s why: Since shares in private companies are often valued just annually, the actual FMV of the business may be lower than the most recent valuation. That makes exercising stock options after the next valuation date an optimal strategy to lower your tax bill.
The Bottom Line
Bear markets and recessions are downright scary for many investors. The good news from a financial planning perspective is that these periods create so many opportunities to optimize your portfolio. Investors and employees, particularly those working in the high-growth tech industry, have the chance to take advantage of today’s market. Your team at Archer is here to help you make the best moves with your equity compensation.
