Stock-Based Compensation Explained and Tax Traps to Avoid

Mindy:
Welcome to the BiggerPockets Money Podcast Finance Friday edition where we talk to my friend JT about how he handles his tech company compensation.

JT:
The three most common kinds of stock based compensation you might see, one is the employee stock purchase plan. The most common form that you’ll see is the restricted stock unit or the RSU, and then some kinds of companies for some kinds of employees will also offer an options package where those employees will get the option to purchase shares of stock at some particular price.

Mindy:
Hello, hello, hello. My name is Mindy Jensen and with me as always is my RSU really smart and unique co-host, Scott Trench.

Scott:
Thank you, Mindy. I’ll definitely exercise the option to be called really smart and unique.

Mindy:
That was good. Very just on the ball. Scott and I are here to make financial independence less scary, less just for somebody else, to introduce you to every money story because we truly believe financial freedom is attainable for everyone, no matter when or where you’re starting.

Scott:
That’s right. Whether you want to retire early and travel the world, go on to make big time investments in assets like real estate, start your own business or participate in the success of your business through an employee stock purchase plan option or restricted stock units. We’ll help you reach your financial goals and get money out of the way so that you can launch yourself towards your dreams.

Mindy:
Scott, I think that this disclaimer is most important on this particular episode. The contents of this podcast are informational in nature and are not legal or tax advice and neither Scott nor I nor BiggerPockets is engaged in the provision of legal, tax or any other advice. You should seek your own advice from professional advisors, including lawyers and accountants regarding the legal, tax and financial implications of any financial decision you contemplate. Also, JT is not telling you how you should handle your stock availability, he’s just sharing how he handles his. Okay, now we are talking to my friend JT, who works at a large tech company and gets stock options, restricted stock units, and the potential for cash as part of his compensation package, his overall compensation package. So we are talking to him today about specifically what those mean and how he handles his distributions.
Before we start today’s show, let’s take a quick break. And we’re back. We are starting a new segment today called Money Moments where we give you our best tips, tricks and money hacks so you can make the most of your financial journey. Here’s today’s tip. Did you know you can buy discounted gift cards for restaurants, spas, amusement parks, movie theaters and travel, and if you live in Colorado, for skiing at Sam’s Club in Costco? Those gift cards are good for gifting as well as your own personal use and the usual discount is around 20%. For example, you can buy $100 worth of gift cards for California Pizza Kitchen for only $80, instant 20% savings. Do you have a great tip? We’d love to hear it. You can share it with us by emailing [email protected] Let us know if we can use your name so we can give credit where credit is due. Today we’re chatting with my friend JT, who works at a big tech company. JT is here to share how he handles his RSUs. Welcome to the BiggerPockets Money podcast. I’m so excited to talk to you today.

JT:
Thanks, Mindy. I’m glad to be here.

Mindy:
Before we start, let’s get a little bit of backstory on you so our listeners understand where you’re coming from.

JT:
Sure thing. Well, I have always been interested in computers and technology. I was every bit the mid to late ’90s high school nerd that you could imagine from all the movies, and I was able to take that interest in computers and math and science, get a bachelor’s and a master’s degree in computer engineering and build that into a career developing and designing microprocessors. So I’ve worked for companies like Intel, AMD, Apple, Samsung, Amazon, Google. Some of those I’ve worked for, some of them I haven’t, but those are the kind of companies that will really go and decide, hey, I need my own little computer chip to do something. And that’s what I help work on, it’s a pretty awesome job.

Mindy:
That sounds like something I am never going to be competing with you for a job for. Okay, let’s get into your compensation. Let’s talk about this whole concept of extra compensation or bonus compensation. Can you explain the framework surrounding stock-based compensation?

JT:
Stock-based compensation is pretty common in some fields and less common in others. And in my field in tech you’ll hear programmers, software developers, hardware designers will often have a pretty significant, or even the majority of their final compensation be due to stock rather than due to salary. Different companies are going to handle this in different ways that are consistent with their culture, but it’s very common in tech companies ranging from the smallest startup to the largest public companies to have a pretty meaningful part of their employees’ compensation be in some kind of stock-based scheme. The three most common kinds of stock-based compensation you might see, one is the employee stock purchase plan, which is not really a compensation. It’s really more of a perk or a benefit you might have working in a company. And I think that’s more broad across a variety of different kinds of companies and not just tech.
When you really start getting into compensation packages, the most common form that you’ll see is the restricted stock unit or the RSU, and then some kinds of companies for some kinds of employees will also offer an options package where those employees will get the option to purchase shares of stock at some particular price. Though all these things are kind of different and they differ a lot in the particulars, they all kind of follow the same general path as you go through your career. There’s a point where the company says, okay, I’m going to make you a grant or give you an offer where if you meet a certain set of requirements, we will either sell you stock or grant you stock or possibly grant you an option. So that’s the grant phase. Over time, as the employee meets whatever those requirements might be, those areas of compensation will vest.
Oftentimes they’ll vest over a period of time, but some of these things will vest kind of all at once and that is when the stock goes from not really under your control and not really yours, it’s just a promise, to actually being under your control and you can sell it, you can vote with it, you can receive dividends because you own it. All the benefits of being a shareholder are now yours for those shares. And then the last phase that’s part of this compensation is at some point maybe you’ll want to sell that stock and all three of these different forms of compensation have a lot of different rules when you sell around, how is it taxed? How much are you taxed on? Does it matter when you sell versus when you got it? But that’s going to be the third phase is when you decide, hey, I don’t want this stock anymore. I either need the cash or I want to be in some different financial position than just having all this stock in one company.

Scott:
JT, are these different types of packages, in your experience, available typically with public companies, large public companies that are going to offer their employees this or do you have any experience with folks who have gotten these types of interests in privately held companies or smaller businesses?

JT:
So it depends on which package it is. Employee stock purchase plan I think is typically only available to larger companies that trade publicly, but when you start looking at a little bit restricted stock and then definitely in the option space, those will be available more in smaller companies and in startups. For a lot of tech employees who really like working at startups and really want to make that part of their career, oftentimes the salaries are going to be lower and most of their upside for working at that startup instead of a larger public company is going to be the options in that company that they receive as part of their compensation package. And that trade off is you end up in something more uncertain. Lots of startups fail and your options are going to be worth $0, but there’s always the chance that you’re working for the next Uber or the next Stripe or the next big giant large tech company that when they decide to go public or sell to a private equity firm, whatever their exit is, you now get this huge payout that would have been practically impossible for you to see at a large public company if that’s where you took your career.

Scott:
Awesome. Let’s get into definitions a little bit more deeply. Let’s explore the difference between an employee stock purchase plan, restricted stock units, and then options.

JT:
Sure thing. And we can frame it in terms of those three phases of the grant, the vest, and then the sale. So the employee stock purchase plan is going to be the most common one, it’s available across lots of different companies, across lots of different sectors. And the grant for that or the offer involved there is you as an employee will have an option to take some of your salary and put it aside in some special escrow account for some period of time, and at the end of that period of time, the company will use that money to buy stock oftentimes at a discount and then you’ll have control over that stock. Different companies are going to do this in different ways with different times and different discounts, but a common grant might say if you put in some percentage of your salary, it’s usually up to maybe 15% of your salary from the beginning of April through the end of September, we’ll purchase at the end of September, you’ll get a 15% discount and you’ll get that 15% discount on the lower of the price at the beginning of April or the price at the end of September.

Scott:
So my old company used to have this option and the limit was you could put up to $25,000 into the plan and buy all the stock at a 15% discount. I’m not sure if we had the same rules at the lowest price in that range, but you could also just sell the stock the very next day after it was bought. So you’d put all your money aside for the quarter in a pool of maybe, I don’t know, five 10 grand, buy the stock and then you’d immediately have 15% more value inside, just sell it and pay the short term capital gains tax. And I didn’t want to invest in the company necessarily, I just wanted to take advantage of that perk. I would highly encourage anybody listening to explore their ESPP plan at work and consider doing something with that because it is a perk typically, and depending on the rules of your plan, you may have the option to do what I was doing, for example. Yeah, there’s a risk that could go down that one day, but I did it for three or four quarters before I left and every time made a nice 15% gain. Again, short term capital gains tax apply for sure, but it’s just a why wouldn’t I take the few thousand extra dollars? Is that your opinion on those plans as well?

JT:
Yeah, that has been how I’ve approached those plans as well. Every company I’ve been at that has offered an employee stock purchase plan, I have taken advantage of that plan and done the same thing that you did. As soon as the purchase settled and came under my control, I would sell it immediately and take the difference between the amount that I got the stock for and the amount that it currently was and just take all of that as either income or short term capital gains depending on what it had done in the two or three days between the purchase date and the settlement date. There is some risk there though. Some companies are incredibly volatile and you might have a really bad news event that happens the day that the sales there and the stock does go down more than 15% in the three days or so before they purchase and you’re able to sell it. I think that’s not super common and like you I haven’t experienced that, but it is there as an outside risk.

Mindy:
Okay. Scott just said “I didn’t want to invest in that company, I just wanted the perk,” and Scott’s last company shall remain nameless, although if you listen to this show you know which company it is, so it wasn’t part of his plan to own stock in that specific company. Does your opinion of the financial viability of the company have any influence over your decision, or would you handle your RSU the same no matter what?

JT:
So there’s what I would theoretically do and what I have actually done. I think like everything else that you all talk about, the important thing I think is to have a plan and to decide ahead of time what it is that you want to do with that money. The main way that I like to think of it is imagine I was walking down the street and I found $1,500 lying on the street or whatever, and I picked it up, would my first thought be I’m going to go take this $1,500 and go buy my company’s stock with this $1,500? I think for most people in the financial independent space, that’s not what they would do. We’ve had beaten into us, and I think rightly so, that index funds are better than trying to pick individual stocks that you’re almost certainly going to do better picking a broad basket of stocks than betting it all on one individual company.
But I see a lot of people that as soon as it’s not cash, it’s stock and it’s stock in the place that they work and they want to think that it does well and they want to think that it’s only going up from here and I think they get maybe a little overly optimistic and maybe they think they have more knowledge than they actually have over how their company’s going to work. My opinion is if you actually do have that knowledge, you’re under very, very careful watch from your company to make sure you don’t violate insider trading laws. And if that’s not you, you probably don’t have as much knowledge about the upcoming financials of your company as you think you might. So I think unless your plan is if I found $1,500 on the street and I’d go turn around and put that right into my company stock, that you should try not to be fooled by either the tax implications.
And there are some really beneficial tax consequences to holding some of these things for a longer period of time, especially when you start looking into options, but don’t let the tax tail wag the dog and then try not to get overly exuberant about your opinion of what your company’s going to do unless that’s your plan. If you think, hey, I think there’s upside here, I want to take a gamble. This is no more or no less of a gamble than me betting on any other company in the stock market just because I work there, but I want to take a gamble and try to capture some upside that I think is there. I think that’s fine and I’ve done a little bit of that, but largely I think most people are better served by selling and following their current investor plan for where my next dollar of money goes to meet my financial goals.

Mindy:
When it comes to selling this stock at a discount, Scott, you sold it the next day, can you make a game time decision or do you have to initiate the sale in advance and just hope it doesn’t go down between the time that you initiate and it actually sells?

Scott:
I can actually take for my situation because I was on the finance team and we prepared the financials for that, I had to set up a such system with the HR group in advance that said, “I’m not trading on any insider knowledge. I’m just setting up my plan to set it to buy the maximum amount of this stock and then sell it the next day ahead of time.” I clearly don’t have knowledge about what’s going to be true three months or six months or nine months down the road, I’m just setting up that as the parameters of my plan way in advance and there’s no way my knowledge of the business could or could not impact that. I’m just taking advantage of the perk and harvesting a 15% spread.

JT:
And I have never been in that position where I have actually known more about the financials of the company than you could read from any of their publicly facing documents. So for me, as soon as that stock settled, I could sell it as though it were any other stock in a brokerage account that I had for many companies. Some companies will impose a blackout period where no employee is allowed to trade that stock, and usually it’ll be sometime from several weeks or maybe a month before the end of the quarter until when they announce results so that they can just be sure that everything is public information and I’ve had to sign agreements saying, I’ll abide by these blackout periods as part of my employment contracts for some of the companies that I’ve worked for.

Mindy:
So how frequently does one receive stock-based compensation?

JT:
That’s another one of those things that varies pretty broadly from one company to another. At the companies that I’ve worked for, there are typically three events as part of your career where you may be granted some form of stock. A common one is when you sign on to the company, so the company might say, “Hey, we want you to come work for us. Here’s the position that you’re going to have. Here’s what your salary’s going to be, and then we’re also going to make a stock grant for you of restricted stock or maybe options or maybe you get to choose what you would like to have that compensation take the form of.” Oftentimes the sign-on grant will have a very specific vesting schedule. Investing again is when the shares become available for you to have control over and do what you want with them. A very common investing schedule will be to say you don’t get any stock for the first year.
At the end of your first year being employed at this company we’ll give you 25% of the shares represented in this grant, and then over the next three years, every quarter you’ll get an additional one 16th of that grant. So that vesting schedule is kind of known in the industry as a four year grant with a one year cliff that will vest quarterly. So you get nothing for a while, you get this big chunk of the year, which is always really exciting, and then you get bits and pieces of it through the remainder of that grant. The other times you might see additional grants are if you’re promoted, sometimes that will come with a grant as well. You’ll get some salary increase as part of that promotion and then an additional grant that may have the same vesting schedule as your sign-on grant. Less frequently you’ll see the cliff because if you’ve been promoted, they already know that you’re doing good work and they don’t need to try to keep you there for a year to make sure everything’s going to work out. So it might just be you’ll get one 16th every quarter or one eighth every six months or however it is they decide to do their vesting schedule.
And then some companies will also do additional grants as part of their semi-annual or annual performance reviews. So when I go through and talk to my boss, I might get some amount of a salary raise and then a follow-on grant. Sometimes it’s called a refresher grant as well. And that just keeps that flow of restricted stock coming to me as I work through the company. Different companies will work differently. I’ve worked at companies that’ll do a sign-on grant, and then that’s really kind of all the stock that you see. I’m aware of companies that instead of doing these refresher grants every year, they might give you a grant when you sign on and say, well, this stock will vest over two years or three years or four years and you don’t see anything until that two or three or four years is up. And then they’ll make another grant based on your performance and how the company’s doing and all those other factors. So they do tend to work a little bit differently, but this sign-on bonus with annual refresher I think is pretty common, especially in the tech industry.

Mindy:
It sounds like when you are negotiating your employment compensation or presented with it, you need to read the fine print, read it all the way through instead of just listening to what HR says, “Oh, we’re getting through this.” Read all of these documents specifically so you understand exactly what’s going on.

JT:
Oh, 100% yeah. It’s very important for RSUs. And then when you start getting into options, options especially at smaller companies, you really need to have a good understanding about how your company’s specific program is going to work and what the risks are for you, what the tax implications are for you, and what the potential upside is for you as well. Another point on that is oftentimes the stock-based compensation is one of the more negotiable parts of your sign-on compensation package. And depending on the company, you may be able to bias your compensation either towards salary, you might say, hey, I would like an additional $10,000 a year on salary, but you can take $80,000 off my grant. Or you might say, hey, I’m willing to take a smaller salary, but I want a larger amount of this stock-based compensation just depending. Some companies will allow that. Some companies have less flexibility there, but it will allow you to bias your compensation to fit your preferred risk profile for your career.

Scott:
I think that to highlight what you’re saying here, this is an investment decision in a lot of cases for a lot of folks to bias your compensation one way or the other. I am an aggressive personal finance nerd with all this stuff and I like to make probability a weighted thing. So in first of all, I would want to think that I would try to join a company that had good growth prospects. That’s the gamble part of it, but that’s something I would try to research very heavily with that. And then I would probably want to bias if I were able to do that, and I thought the company was fairly valued more towards the option upside and less towards the cash compensation today. But that’s a trade off that I think a few people understand very well. So for example, if you had a choice at a public company that had a higher salary with a fair but not glamorous option pool and a startup that just raised money at a crazy valuation, the startup’s going to give out equity like candy, right?
Because they just got this incredible valuation from a venture capital firm. Their equity is they don’t have the revenue to support it at this point in time, all that kind of stuff. And that’s something to just be aware of, right? They’re going to try to pay you less that’s going to reduce their expense profile on their income statement and make things look good, and you’ve got a spin, but maybe not a very high probability one compared to a more stable company that’s producing large amounts of cash flow. They might give you less equity, but there might be more of a clear trajectory towards growth and track record as success. And I think that folks don’t really think that through all the time with when they’re making these decisions. Would you say that that’s been true with any of your peer set or folks you’ve known in the past?

JT:
Most of my career has been in larger companies, so I don’t have a lot of experience in that startup options package, but you don’t have to go far to hear stories where even good bets with startups end up being very problematic for individual employees. And I would certainly encourage anyone who’s looking at working at a startup and intrigued by the allure of possibly owning 0.2% of the next Stripe or DoorDash or whatever to really understand the risks that you are you’re taking, even assuming that the company does well. So you should certainly talk to a professional around it, but when you’re really at that part of a company, you take on delusion risk. If the company takes on additional investors, your amount of the company that you own may be less than you think. You take on a lot of tax risk, largely due to… A lot of times you’ll get these options for this private company that there’s no market for, so you still have to So you still have to deal with the tax implications of potentially millions of dollars of value, but you can’t sell your shares afterwards.
And like I said, you don’t have to go far to read stories of people who have gotten into the startup, even a startup that goes well and they just can’t do anything with their stock-based compensation because of the circumstances of their life. So it’s really important to have a good understanding of what happens with these plans in your circumstances, especially for some of these smaller startups.

Scott:
JT, is this a world that is accessible to folks that are at the entry or junior level in businesses or are we really talking about something that is more for the much more senior seasoned engineer, product and technology type worker, executives, those types of things?

JT:
Yeah, that’s a good question. It is going to depend again, largely on the company. I would say most tech companies will have some element of stock-based compensation across their job grades. So if you bring in someone who’s just out of school, some percentage of their compensation will be from these stock-based plans rather than just salary. The higher up you go in the company, usually the larger the impact that stock-based compensation is going to be as part of your overall compensation. You hear occasionally something in the news about how, oh, a CEO of some company or another agreed to reduce their salary to a dollar for just things that are going on in the business. And they neglect to mention that that particular senior employee has $15 million worth of options that are vesting this year that they could take advantage of if they wanted to. But generally in across a lot of tech companies for all job grades, stock-based compensation is a pretty common form of compensation.
So restricted stock is definitely less common than the employee stock purchase plan. It is part of your compensation instead of just being something that you can take advantage of. Again, you can sort of split it up into the grant, the vest and the sale. For the grant, your company will usually say, hey, if you continue to be employed then at some vesting schedule we’ll grant you control over some amount of stock. And it’s oftentimes presented either as a cash amount, they might say, we’ll grant you $10,000 worth of shares, and then at some point the board of directors will approve that grant across all the employees that might fit under that grant. And at that time that $10,000 will be converted to shares, and it’ll stay as shares through the rest of the vesting period. So if you had $10,000 and your stock price was $10 when the board approved the grant, they grant you 100 shares and that would be what you would vest on. As you go through your employment period, when you meet that vesting schedule you just get those shares, and those shares are now under your control. They’re just as though you had purchased them off of the market.
And when they vest, that’s counted to you as income at their current value. So if you had 100 shares that were vesting, and even though if at grant your stock may have been $10 a share, if now it’s $20 a share at that 100 shares it’ll count as $2,000 of income and be taxed as income when it vests. And then from that period, it’s as though you bought it at $20 and all the regular short-term and long-term capital gains are going to apply, but you’ll pay the taxes at vesting time and it’ll come out as income and be taxed as income at the value it is when it vests.

Mindy:
That I think is important to note that you are paying income level taxes, not long-term capital gains taxes on this. And I guess short-term capital gains are basically the same as your income level, right? So it wouldn’t matter if you were getting the options and then instantly selling it. That’s the same thing.

JT:
That’s right. Yeah. So if you were to get restricted stock and then sell it immediately, assuming the stock was flat, there’s probably going to be a little bit of movement, any change in the stock price between when you vested and when you sold would be a short term gain or a short term loss and then the value of the stock when it vested is counted as income to you. One trap people can get caught in here is the withholding rate for restricted stock is not the same as the withholding rate for your income. And especially if you are a high income earner, you might find at the end of the year that you haven’t withheld enough taxes and that you owe more. So that’s a pretty common place, especially for either high income earners who are in some of the higher tax brackets or individuals who have a significant portion of their compensation being stock-based compensation because just the withholding is all different. And as far as I know, there’s no way to elect to withhold more to actually meet your tax withholding requirements. You just either end up needing to pay estimated taxes or make it up at the end of the filing season.

Scott:
So if you come into money and have a big success like this, or really in any other format and are able to put a large amount of cash in your bank account through something that’s other than payroll from your company, it’s probably a good idea to hire tax council and to be very conservative with that money until you have filed your taxes completely and feel like you understand that. Because these types of traps can happen in a lot of different ways if you are used to an employer withholding and handling your taxes more or less entirely for you throughout the year and get a big refund.

JT:
And there are taxes withheld for restricted stock. You’ll typically have an option to either pre-fund your account with your custodian with money to pay taxes, or they’ll sell whatever percentage of shares is required to meet the withholding requirements, but you just need to be careful. For some tax brackets, the withholding rate on RSUs is going to be higher than what your final tax rate’s going to be, and for other higher income earners it’s going to be lower. So it’s just something you need to pay attention to.

Mindy:
So while you may not know of any way to change the withholding for the RSUs, you can change the withholding in your paycheck if you don’t want to pay the IRS on April 15th to any extra that you owe. On episode 360 with Natalie Kolodij, she shared that now is a really great time to sit down with your tax pro to get some tax planning, to do some tax planning for the year in advance. If you know that this is part of your tax compensation or your employee compensation and you are going to be hit with a surprise bill this year, which many people are because changes to the tax law yada yada, maybe now is a really good time to sit down with your tax pro and say, hey, what can we do going forward so that I don’t have this on April 15th? I personally don’t love writing a big check to the IRS, but I would much rather write a check to the IRS than have them send me a check because that means I have given them a free loan for the whole year and I don’t like that. But I digress.

JT:
Well, the IRS is going to charge you interest if you owe them too much, so you got to be careful about that too, because I don’t like paying the IRS more interest than the spread of my savings account, for example.

Mindy:
Yes, and I’m self employed as a real estate agent, so I have to pay quarterly taxes anyway. So my specific situation is different, but yes, I always was fine writing them a check on April 15th.

Scott:
JT, what is your specific strategy with how do you personally handle all of this given the wealth information you shared with us today?

JT:
So for my restricted stock and for my employee stock purchase plan options or shares, those are ones I’ll sell basically immediately. My position is like I said before, if I were walking down the road and found some money on there, I would not go buy stock in my company. And when I looked at the value of that restricted stock, it seemed a better position for me to go turn it into VTI or VTSAX or whatever the rest of my allocation plan looked like. There have been times, so I’ve been at my company for a number of years now and there have been periods of time where that was a very unfortunate financial decision and had I held onto the company stock and sold it later, it would have been a meaningful difference in our financial position to the tune of several hundreds of thousands of dollars. There have been other times at the same company where I have been very glad that I have sold my restricted stock immediately because the current price is down quite a bit from some of the levels in which I sold.
And I’ve just learned from me, I can ignore my index funds for months or years at a time and it’s fine, but you give me one share of company stock and I’m looking at it every day. Is it up today? It’s down today? Has it been up for the week? Has it been down for the week? So I clearly don’t have the temperament for individual stock investing, but if I go put it in an index fund I’m happy to leave it alone and let it grow. And it doesn’t freak me out, whether it’s up a little or down a little or up a lot or down a lot. It just does its thing.

Mindy:
Okay. I love that. You have a plan, and just like paying extra on your mortgage even when it’s a 3% mortgage rate versus not paying extra on your mortgage, it gives you the heebie-jeebies to have this stock in your portfolio. You don’t want to be an individual stock portfolio or an individual stock investor, so what that tells me is you’ve thought about it. I think that’s the most important takeaway of this entire episode is that you need to think about what you are doing with your investing strategy. What is the episode… We just did an episode about coming up with an investment plan, and that was episode 362, come up with an investment plan and follow it. And I don’t want to say it doesn’t matter what you do as long as you have a plan, it kind of matters what you do, but most important is that you think about it. You hear about these people who are losing everything in crypto or losing everything in meme stocks, it’s because they’re getting in at the end. Oh, everybody’s talking about it. It must be good. That’s not true necessarily. Just because everybody’s talking about it doesn’t make it good. It just means everybody’s talking about it. Okay. So given that you work for a tech company and tech stocks are down, is there any threshold that you would not immediately sell?

JT:
So there are, and we could also I guess talk a little bit about options if we want to talk about options.

Mindy:
This is specifically for RSUs, which those are granted to you. Those are given to you. So you’ve paid $0 for it, so even if it was worth a penny when you sold it you’ve still made money on it.

JT:
And I think every RSU grant I’ve gotten, or every RSU I’ve had that’s vested I’ll sell within a couple weeks to exit that position and funnel that money into the rest of our financial plan.

Mindy:
So RSUs you’ll instantly sell. You have RSUs cash and options, have you ever taken the cash?

JT:
No. And like I said, different companies will work differently in their performance reviews. My current company, oftentimes when they do the performance, the merit compensation for this longer term stuff will have a choice between whether we wish to take that amount in cash. That still vests, all the vesting is effectively the same, but they’ll say, hey, we’re going to give you $10,000 of compensation. You can have $10,000 of cash that vests over three or four years or whatever. You can get $10,000 worth of restricted stock or you could get that $10,000 in options. And then at this company, we get to elect which one of those things we want that whole award to be given to us in.

Mindy:
And is there any threshold that you would not sell? Obviously if you take the option, you have the option to buy X number of stock at this price. So if the stock let’s say it’s $50, if the stock is currently trading at 35 it doesn’t make sense to buy it at 50 and sell it at 35 unless you need losses. But I don’t know, I don’t like losses.

JT:
No, I don’t do that.

Scott:
What they’re doing is they’re giving you… So let me ask you this from a psychological standpoint. When I was doing the SPP my colleagues didn’t do it and I was kind of baffled by it. Why wouldn’t you do this? And there’s I think a psychological element of, no, this is a test for my employer. And you could wonder if in your situation if employees might be thinking this is a test, the options, if I take the option option, the option option, that then that means that I think that the company’s going to blow up and do great over the next couple years. The RSUs, ’cause I just own the stock, are a more middling option. Even if they go down, they’ll still be worth something so I have some value there. And then the cash is the most conservative. Do you think there’s any element of that to be factored in or is that all in people’s heads?

JT:
I think largely that’s in people’s heads. The way that I look at it is it gives you an opportunity to shape the risk profile of your compensation. You can really like the company that you work for and think that it’s going to do really well and not want to own its stock. You can really not like your job and then think your company is terrible, but on the off chance that it has a really great year and the stock price quadruples in value, you want to be open to that upside. So I think that election really says more about the way you want to shape your compensation and the amount of risky you want to take as part of your career and your salary more than that you think there’s some director or C-level executive who’s looking at a spreadsheet of everybody who took cash instead of options and are like, hmm, I don’t know about that one. Clearly they’re not invested in the company.

Scott:
Okay. And then last question I’d have is around taxes. Let’s go, I’ll use my example. I had an employee stock purchase program. If I put 10,000 of my salary into it I could buy $1,150 worth of stock at 15% discount. That then I turn around and sell it. That 1,150 not only am I getting tax on my salary of course, but I’m also getting taxed on the short-term capital gain, the one day capital gain of that spread between 1,150, I could have left that money in the stock for one year in order to convert that from a short-term capital gain to long-term capital gains tax. At that point it didn’t matter very much because my tax bracket was very low and they were very comparable, but for some folks that might make a big difference. How would you propose approaching that problem? It sounds like you sell immediately for a lot of this stuff, but are there circumstances, can we tweak those circumstances in such a way where you would begin playing the tax game?

JT:
Sure. And I think the place that you do that is with options. So the nice thing, the simple thing about restricted stock is when you vest that’s all income, you can’t do anything about it. You have number of shares times value of shares, amount of income that is attributed to you and you owe taxes on it right away and that’s your cost basis for the stock. So yeah, the stock may go up a little bit or down a little bit between when you vested and when you’re able to sell, but there’s not really a lot you can do from a tax perspective at that point. The employee stock purchase plan like you mentioned, there are some real tax consequences to holding for either one year or it gets even a little better at two years, especially if you have that look back period. So if you have to look back, you could say my stock, the value of the stock at the beginning was a 100 and now it’s 150 and I still pay 85. So when you sell the 85 to 100 is always income. That 15% discount is always, always income. Depending on when you sell the 100 to 150 maybe income, it may be long-term capital gains. And I think it’s usually you have had to have held the stock for a year and it has to have been two years past the grant date.

Scott:
Wow. So I’ve made the right decision, but out of ignorance, not out of smarts.

JT:
Well, and I think you mentioned your plan didn’t have this look back provision in it anyway, which is really where this extra piece comes in. For employee stock purchase plan for most people, I think I take the same perspective you do and that the values just really aren’t large enough to make enough of a difference in your financial position to really worry about or to justify the risk of holding onto that stock for 12 to 18 months given whatever volatility might be in the stock. Different people are going to calculate that risk differently, but I don’t think the extra taxes on that $50 per share warrants holding onto that stock for two years. Options are going to be a somewhat different story because they can be worth a lot more, and there’s a kind of option that has a similar kind of tax behavior as the employee stock purchase plan, and those are the incentive stock options. And those will allow you to say, okay, I’m going to exercise this stock. There’s a difference. So they could say, hey JT, we’re going to give you a bunch of options at $1. Which is great. You have the option to buy your company’s stock for a dollar.
If the stock price is $10 when you exercise those shares, then it all starts becoming interesting. What do you do with that extra $9? For some kinds of options it’s the same thing, that’s income. And it’s income right away and you need to account for taxes on that income. For these incentive stock options, it’s not necessarily income depending on when you sell. So if you hold the stock for a year after you exercise and two years after the grant that $9 is long-term capital gains. And if the company has gone up enough and the amount of number of shares that you have is enough now you’re not necessarily looking at 10% of $500 or whatever, you’re potentially looking at top bracket earner in the state of California. This is potentially hundreds of thousands of dollars for holding the stock for a year versus selling it immediately. And again, that’s going to be an individual decision. Do you think it’s worth taking the risk of holding on to that stock for the year until you’re able to sell it? Or do you not want that risk, you’re willing to pay the taxes and you’re willing to sell and go into whatever else your financial plan has for those extra dollars? But it can end up being real, real money depending on what the company’s stock price has done and when you decide to exercise.

Scott:
JT, this has been fascinating. Thank you for coming on the show and discussing this topic with us. I think that it’s some folks, hopefully many of our listeners have the opportunity to participate in plans like what we discussed today. And when you do, please refer back to this episode and know that there are options for your options and decisions to make that could have major impacts in your life. JT, where can people find out more about you and the financial planning and tax strategy firm that you’ll be starting soon?

JT:
Yeah, I think I’ll stick with microprocessor design. And probably the best way to get ahold of me if you really want to is in your Facebook group. I’m active there, I’ll pop in ahead of time if you want to tag me on there I’m happy to talk about all this stuff or hear disagreements as to why my approach is not the best one to take.

Mindy:
Respectful disagreements.

Scott:
I don’t think you’ll get too many of those, but you could find that group at facebook.com/groups/bpmoney. Thank you for being a part of the group JT, and thank you for listening, and thank you for sharing your wisdom on this pretty complex topic today.

JT:
Yeah, thanks. I had a great time. I like thinking about this stuff, so it’s fun to talk about.

Mindy:
Thank you JT, and I’ll talk to you soon. And that was JT, a big tech employee talking about his compensation package, stock compensation packages in general and how he handles his particular compensation package. Scott, what did you think of JT?

Scott:
JT is super knowledgeable, has clearly given us a ton of thought, has experience across multiple different companies, although mostly public companies as he acknowledged. And has really kind of thought this through and I think in a way that probably has benefited himself and I suspect many of his close colleagues that have benefited from his wisdom over the years. And I’m sure he is done very well and chosen the companies that he works for wisely as well to the point where they probably have produced very well inside of these plans.

Mindy:
Yeah, I think that what is most important to take away from this show is that he has a plan in place. He has given it thought. He has decided that he wants his investment portfolio to look like this, to be comprised of these systems and these portions and these investment vehicles. So that’s what he’s doing. He’s not going off on tangents, he’s not venturing down this path to try this out, and try that out, and try that out. He has a plan and he’s sticking to it, and I think that’s really important. You don’t have to sell your company stock instantly if you don’t want to. If like he said, you found $1,500 on the street and you would go use that money to buy your company stock anyway, then getting the grants and holding onto that stock is great. That’s a great plan, but that’s the key word here. It’s plan. He has a plan in place and he’s executing his plan and I think that’s really great.

Scott:
Yeah. I also think that towards the end we heard this framework and it was, well, if I had invested in my hotshot tech company I probably would be up a few hundred grand over my index fund strategy. Yet, he is also happy with that outcome or can live with it because he’s not thinking in terms of outcomes, he’s thinking in terms of bets. Probability based thinking, Thinking in Bets with Annie Duke is a great book, for example, to understand this. He says, my portfolio, my plan is this and I’m happy to live with it even though I probably actually would’ve done better if I had dumped it all at my company stock. That’s a really wise position to take in my opinion, and something that I think is hard for a lot of people. I think it would really hard to miss out on company growth like that, but I think I respect his approach and would be likely to take the same steps he’s taking in his position.

Mindy:
His company could very well have gone the route of Enron or WorldCom where he got the grants, held onto them and then lost everything. Just because his company went up doesn’t mean that it’s always going to go up. He works at a big tech company right now the stock is down, but that doesn’t mean that it’s always going to be down. It’s just like you said, it was a gamble. Like he said, it was a gamble. He was gambling on the stock being different than it ended up being and that’s okay. He took an educated gamble, guess, and it didn’t work out. He’s still doing well. It’s not like he lost everything. He just didn’t see some of the explosive growth that other people did. But he also said, I don’t have any issue with what’s going on with my index funds. Those are set it and forget it. In his mind, he can put money into the index fund and leave it. In his mind, if he owns even one share of his company stock he is constantly thinking about it and that is not worth the mental real estate that it takes up to him. So he has foregone that in an educated way, and I think that’s the right maneuver is just have a plan and stick to it as much as you can.

Scott:
I agree completely.

Mindy:
Well, you have to because he’s right. Okay. That wraps up this episode of the BiggerPockets Money Podcast. He is Scott Trench and I am Mindy Jensen saying Chow Chow Brown Cow.

Scott:
If you enjoyed today’s episode, please give us a five star review on Spotify or Apple. And if you’re looking for even more money content, feel free to visit our YouTube channel at youtube.com/biggerpocketsmoney.

Mindy:
BiggerPockets Money was created by Mindy Jensen and Scott Trench. Produced by Cullen Bennett. Editing by Exodus Media. Copywriting by Nate Weintraub. Lastly, a big thank you to the BiggerPockets team for making this show possible.