“Chris – My company just lifted the second trigger on my RSUs and is offering me the ability to sell shares in a tender offer… What should I do?”
I’ll start by saying this is an exciting milestone that your company has achieved! For some of you, this may be the first time you have the ability to realize the value of the equity that was granted to you upon joining the company. While there may be future opportunities to sell shares, you have some decisions to make today that will affect your tax situation. Let’s start by understanding what this means from a tax perspective & how to think about making decisions for your personal situation.
What is a “double-trigger” RSU?
Many late-stage, private companies shift from issuing stock options to Restricted Stock Units (RSUs) as the company’s valuation surpasses the $1B mark, as a way to continue incentivizing employees to grow the business. Unlike stock options, where one has the right to “exercise” or purchase shares in the company at a set price, RSUs do not require any cash outlay to purchase shares. This can be attractive when the company’s internal valuation reaches a level where the costs to exercise the stock options may be cost-prohibitive for new hires who join the company.
With RSUs, there are no taxes due on the grant date. The taxable event occurs on the date shares vest. When a private company issues RSUs to employees, they are typically issued as “double-trigger” RSUs, meaning there are two events that must be satisfied before the shares become vested. The two triggers are 1) time-based vesting and 2) event-based vesting. A common time-based vesting schedule is over 4 years, with a 1-year cliff. The term “cliff” simply means you must stay with the company for at least 1 year in order to vest the first 25% of your shares. The event-based trigger is a provision that is included within the RSU grant agreement that specifies the shares won’t officially vest until a “change of control” or “liquidity” event occurs. The most common event-based triggers are an initial public offering (IPO) or company acquisition. The reason for this second trigger is primarily for tax purposes, since the vesting of RSUs is a taxable event, the company doesn’t want employees to have a tax liability without having access to the share proceeds to cover the taxes due.
What does this mean from a tax perspective?
When a private company lifts the second trigger condition on RSUs, the number of shares that have vested during your tenure at the company will now be taxable based on the company’s current price per share. For example, if you have 10,000 RSUs outstanding and the company’s Fair Market Value on the date they remove the second trigger condition is $92.50, this means you will recognize $925,000 of ordinary income as a result of the shares vesting. From a tax perspective, this income is treated the same way as if your company paid you a cash bonus of $925,000.
In the eyes of the IRS, RSUs are considered a “supplemental income” source, therefore the default tax withholding rate is 22% for any supplemental income less than $1 million. Above $1 million, the default Federal withholding rate is 37%. For many individuals who are vesting RSUs, this will result in a higher than normal income year and therefore they will personally be in a higher tax bracket than what they are used to. That said, it’s important to make sure you plan for the tax liability that is due as a result of your RSUs vesting.
For example, a couple who files a joint tax return in 2025 and has household income of $300,000 between their combined salaries, would fall in the 24% tax bracket. If one spouse vests 10,000 RSUs which results in an additional $925,000 of income, this brings their total household income to $1,225,000, and now pushes them into the 37% tax bracket. The default withholding of 22% would only cover $203,500 of Federal taxes on the RSUs, which would leave the couple with a tax balance of over $116,000 due to the withholding deficit!
How to avoid tax surprises:
The simplest way to ensure you don’t have an unpleasant tax surprise is to elect for additional withholding upon your RSUs vesting. By electing to have a higher withholding rate, the company will sell additional shares and use the value of those shares to cover your associated taxes.
“But Chris – I’m bullish on my company and I want to hold on to as many shares as I can”.
I hear this from a lot of individuals who I speak with and that’s a reasonable approach. If you opt for the default withholding of 22% so that you can retain more shares, then it’s critical you understand what your projected tax balance is in advance and you have an alternative source of funds to cover this tax balance. Additionally, you should verify your withholding has satisfied the IRS Safe Harbor, so you don’t incur any penalties on your tax balance throughout the year.
Since RSUs are treated as ordinary income upon vesting, the value of proactive tax planning becomes even more important when you’re in a higher tax bracket. To help reduce your tax liability in a high income year, maximizing tax-advantaged accounts such as, Pre-Tax 401k’s, Health Savings Accounts, Flexible Spending Accounts, and 529 Education Savings Accounts, are all great options. Additionally, prefunding multiple years worth of charitable donations via a Donor Advised Fund to “clump” this contribution into one tax year can help to increase your total deductions and therefore lower your taxable income. Two additional planning opportunities in a high-income year are exercising additional ISOs to take advantage of a larger “AMT Gap” or using proceeds from the tender offer to increase contributions to your After-Tax 401k and convert these funds into your Roth 401k.
Should I sell shares in the tender offer? If so, how much should I sell?
I’ll start by saying that I believe choosing to participate in a tender offer and not participating are both reasonable decisions. It truly depends on your personal financial situation, your risk capacity to hold a concentrated stock position, and the benefits of cash today vs. potential cash in the future. Before sharing how I help individuals navigate what makes sense for their situation, I’ll debunk a couple myths that I frequently hear.
“I’m not going to sell any of my vested RSUs because I don’t want to pay additional taxes”. ❌
As mentioned above, RSUs are taxable as ordinary income upon vesting. The stock price on the date of vesting becomes your “cost basis” for the shares. If the shares vest at $92.50 and you sell the shares at $92.50, there is no additional tax that you owe upon the sale.
You would only pay tax if the stock price increases above your cost basis and you sell your shares at a future date. If you hold these shares for more than 1 year from the vesting date, then any upside for your company’s stock price would be treated as a long-term capital gain.
“I don’t need any cash now, so I’m going to hold onto my shares until we IPO”.
There’s nothing wrong with this approach, however, there are few considerations to be mindful of before making this decision. First, make sure you have your tax liability covered from any RSUs that vested. Secondly, if you hold any unexercised Incentive Stock Options (ISOs) and you’re optimistic that your company will be worth more in the future than it is today, exercising these options ahead of an IPO can help to maximize your upside on these shares. Lastly, while you may not need the cash today, the timing of the next liquidity event is uncertain. If your company IPOs later this year, it’s likely you would be subject to a six month period where you’re restricted from selling shares. That said, make this decision fully aware that it may be 12-18 months before your next opportunity to receive liquidity for your shares.
To help you determine if selling shares in a tender offer makes sense, I encourage you to reflect on what this money could provide for you and your family today. I’ve recently had a few conversations with individuals who have chosen to participate in a company tender offer and they are using the proceeds for the following reasons:
- Putting a larger down-payment on a house that their family can grow into, while making their mortgage payment manageable from a monthly cash-flow perspective.
- Using the proceeds to facilitate a job transition to a lower stress, though less lucrative job, that enables them to spend more time with their family.
- Paying off their student loans & making a lump-sum contribution to their 2 year old child’s 529 education savings account.
Additionally, if you previously incurred Alternative Minimum Tax when exercising ISOs, selling the shares that caused you to incur AMT at a higher price than the Fair Market Value on the date of exercise can enable you to recover AMT via a tax credit.
While there are many reasons to be optimistic about your company going forward, you never can be certain what the future holds. For many individuals, if you have the opportunity to convert a portion of your equity into money that you can use to accelerate a financial goal or set yourself up for a strong future, I think it’s wise to consider selling at least 10% of your overall stock exposure. If your company reaches the potential you expect, you still have 90% exposure to financially benefit from additional upside! Additionally, if you remain with your company, it’s likely you will receive subsequent equity grants or continue vesting RSUs, which further increase your company stock exposure.
