Equity that vests whether or not you are ready

Transforming challenges into opportunities

Equity compensation is taxed on a schedule the executive does not control. The only variables that remain are withholding, the timing of an exercise, and whether the deferral election was made before the door closed. All three are calendar problems.

Challenge

Andre is a senior executive at a studio. His pay is $650,000 in salary, roughly $900,000 a year in vesting restricted stock, and a block of incentive stock options he had been meaning to exercise. He had been surprised by his tax bill three years running.

• A withholding gap built into the default. Vesting equity is withheld at the 22 percent supplemental rate. His marginal rate, federal and state combined, was above 50 percent. The difference had been accruing silently all year.
• An exercise with an unmodeled consequence. Exercising the full option block would have triggered alternative minimum tax he had never calculated and did not know applied to him.
• A deferral deadline passing unnoticed. The election to defer the following year’s bonus had to be made before that year began. It had lapsed twice.

Strategic response

No entity was formed and no product was purchased. Three dates were put on a calendar and the arithmetic was done before each one.

• The gap closed inside the year. Additional withholding requested through payroll and sized to the actual shortfall, so the tax was paid as the income was earned rather than in a lump the following April.
• The exercise sized to the crossover. Alternative minimum tax modeled before exercising, and the option block exercised in tranches up to the point where AMT would begin, with the balance carried into the following year.
• The deferral election filed on time. A written calendar reminder ahead of the election window, and $200,000 of the following year’s bonus deferred to post employment years under the plan’s own terms.
• A written sell schedule. Shares sold on a fixed schedule at vest, so a tax event and a market timing decision stopped being the same decision.

Result

The tax owed did not change. What changed was when it was paid and what it cost to be surprised by it.

• April balance due of $3,100. Down from $214,000 the prior year, with no underpayment penalty.
• AMT of $0 on the exercise. Against roughly $88,000 that a single unmodeled full exercise would have produced.
• $200,000 deferred on time. Elected before the window closed, moving income into years when his rate is expected to be lower.
• No forced sale. Nothing had to be liquidated in April to fund a bill, which in two of the prior three years it had.

Conclusion

Nothing here reduced the statutory tax on a dollar of his compensation. It removed the penalties, the alternative minimum tax he did not need to trigger, and the annual forced sale. For an executive whose income is set by someone else’s vesting schedule, that is where the recoverable money actually is.