Believe it or not, selling stocks require a strategy that is just as important and detailed as buying them. There are a few scenarios where selling your company stock to raise cash makes sense. It generally has little to do with market activity and a lot to do with your personal circumstances as a Millennial in tech.
As history proves, successful investing isn’t a matter of timing the market. It’s more about responding to changes in your life and your portfolio. For reasons beyond your control, you may find yourself in a position where you suddenly need to come up with cash. In an ideal world, you would have a cash reserve in a high yield savings account to meet urgent or unexpected expenses.
Alternatively, the proceeds from selling shares of your company’s stock, acquired through equity compensation, can be a useful source of income as well. However, you must proceed with caution when selling company stock to raise cash.
If you’re considering selling your company shares, there are a few concepts and tax consequences you must know. To guide your decision making around this topic, I’ve put together some main points you should consider.
Identify the best shares to sell
When you hold company shares you’ve received at varying prices and moments in time, it’s advantageous to clearly identify which shares are best to sell. This strategy is an investment accounting approach known as Specific Share Identification, where an investor’s objective is to optimize their tax treatment when selling company stock to raise cash.
For instance, let’s say you’re awarded RSUs, and receive 1,000 shares that will vest over four years. Each year, the price per share, also known as your cost basis, is increased by $5. In this scenario, you’ll receive 250 shares at $10 per share in year one. In year two, you’ll receive 250 more shares for $15 per share. In years three and four, you’ll receive 250 shares, but at $20 and $25 per share, respectively.
As you can see, these shares will vest at different prices, and if you decide to hold them rather than selling immediately, they will have different holding periods. If an employee were to sell a portion of their company stock to raise cash, there would be different tax implications for each group of shares. Considering this, make sure to get clarification on how to indicate specific shares to sell through your brokerage firm (E-Trade, Vanguard, Fidelity, etc.).
Understand capital gains taxation
Capital gains are profits from the sale of a capital asset, such as shares of company stock. Notably, when you sell company stock, you will generate a capital gain or capital loss. The calculation is simple — it is the difference between the sales price and your cost basis. Once you’ve decided to sell your company stock to raise cash, the challenge becomes minimizing taxes on the income received.
If you hold company stock for more than one year after exercising stock options, purchasing shares through an ESPP, or vesting of RSUs, it will qualify for long-term capital gains rates. If you hold the shares for less than a year, it will result in short-term capital gains rates.
The difference between the two is relatively simple. Short term rates are taxed as ordinary income, as high as 37%, while long term rates are capped at 20%. Because of this favorable tax treatment, you are incentivized to sell shares that will result in long-term capital gains as opposed to the alternative.
Know your holding period for ISOs and ESPPs
Capital gains taxation especially plays a role when dealing with ISOs and ESPPs. Holding company stock purchased in an ESPP for more than two years from the enrollment date and one year from the purchase date will lead to favorable tax treatment on the sale. In a like manner, holding shares exercised via ISOs for more than two years from the grant date and one year from the exercise date will lead to lower tax rates.
On the other hand, selling the shares too quickly will result in a disqualifying disposition and will have different consequences for ESPPs and ISOs. To drive my initial point home further, this is another reason to carefully identify the shares you want to sell.
Watch out for wash sales
A wash sale occurs when you sell a stock for a loss, and you also purchase a substantially identical stock within 30 days before or after the sale. You might be thinking, “why would I ever sell my stock for a loss?” Without getting into the weeds of tax planning, the IRS allows you to use capital losses to offset capital gains, resulting in a lower capital gains tax. In the investment world, this is called tax-lost harvesting.
Under wash sale rules, the loss and holding period are carried over to the new replacement shares. For example, let’s say you sold shares of company stock for a loss. Any RSU vesting, ESPP purchases, or option exercises can trigger the wash sale rules if they occur within 30 days of the sale. That is to say, your cost basis from the shares that were sold will be added to the cost basis of the new shares, resulting in a higher cost basis.
Know your company’s post-termination rules for stock options
For the most part, employees typically have 90 days to make a decision and exercise their vested stock options when they leave a company. If you can’t get together the necessary cash and plan for the tax implications for the exercise, you’re likely out of luck. All those vested stock options representing years of hard work will expire, and be rendered useless.
Some companies view this is as a serious burden that many Millennials in the startup world face when they leave a company. Thankfully, there are leaders like Pinterest, Coinbase, and Asana, who have extended post-termination exercise (PTE) windows that reflect their culture and gratitude to employees.
P.s. I found a list of over 150 companies, all of which have extended PTE windows far more than the standard 90 days. I’ve only shared it in my weekly newsletter with The Equity Shop community 😜
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