Tips From Leading Financial Advisors Amid Down And Volatile Markets

Year-end and year-start are key periods for financial and tax planning if you have stock options and restricted stock units (RSUs), participate in an employee stock purchase plan (ESPP), and/or hold company shares. In 2022, year-end planning can be tricky because of the market downturn, volatile stock prices, and job uncertainty.

A December webinar held by myStockOptions.com, a resource on all aspects of stock compensation, presented ideas and tips for year-end and year-start planning from a panel of three leading financial and tax advisors with expertise in this area. This article summarizes some of the key points they made.

The Importance Of Multi-Year Planning

“When we start off with a client, we begin right away with the idea of multi-year planning,” noted webinar panelist John Barringer of Executive Wealth Planning in Denver, Colorado. “We treat every meeting with clients as if it’s year-end. There are so many overlapping issues: trading windows, new grants, vesting.”

Multi-year planning is especially valuable with stock comp, as you can control the timing of stock sales and option exercises, and you know when RSUs will vest. Getting this planning right is crucial, for example, if you are considering option exercises or stock sales at the end of 2022.

For a start, you need to be aware of the 2022 and 2023 thresholds for higher tax rates on compensation income and capital gains, the phaseouts for various tax credits, and the Medicare surtax on investment income. If you believe your tax rates will be higher in 2023 and beyond, you want to consider whether to accelerate income into 2022.

Webinar panelist Rebecca Conner, the founder of SeedSafe Financial in Austin, Texas, outlined her systematic approach to multi-year planning. “What we do for all of our clients is just lay out what we expect each year and then see what we can play with,” she explained. “If they’re receiving RSUs as well as nonqualified or incentive stock options, we’ll map out RSUs over the years and where we think taxable income is going to be. Then we’ll see how we can pop other things around and fit them in over those next few years.”

Stock Option Exercises: Variables To Consider

As Rebecca acknowledged, the vesting dates of RSUs are fixed, so you can’t control when you receive RSU income at vesting. By contrast, you choose when to exercise stock options, making them a variable to play with in multi-year planning.

Example: You are a joint filer with $290,000 of taxable income in 2022 and projected taxable income of roughly the same in 2023, putting you in the 24% tax bracket. You also have a $100,000 spread on your nonqualified stock options (the grant will expire in March 2023). By exercising just enough options in 2022 to generate $50,000 of additional income (giving you $340,000 for the year), you can then exercise the remaining options in early 2023 and avoid the higher 32% tax bracket in both years.

However, many advisors emphasize that taxes should not be your only consideration in year-end planning. “At year-end, we don’t let the tax tail wag the dog,” cautioned Rebecca. “The main question is really how much cash are you willing to lose toward options? They’re never a guarantee. It’s important to recognize that this may be a moonshot. If we can treat it like a very small company stock with high volatility, what would you want to put toward that? We’ll recognize what our clients would like from that perspective.”

Other factors in planning for stock option exercises at year-end are holding periods for capital gains and your company’s stock-trading windows, as discussed by webinar panelist John Owens, Director of Financial Planning at Brooklyn FI in New York. “One of the things that’s top of mind is going through what the timeline looks like,” he said. “If you’re doing an exercise on, say, December 8, you might not be able to sell those shares for long-term capital gains next year because your company’s trading window is closed during that time. We need to understand cash-flow needs for clients and how long they actually want to hold the stock.”

Incentive Stock Options: Year-End Dilemma

The advisors emphasized that in a down market it is crucial to review incentive stock option (ISO) exercises that you made earlier in the year if you are still holding the stock. Selling that ISO stock before the year ends removes the spread at exercise from the AMT calculation, thus eliminating the need to pay the AMT on it. However, making that move also means you don’t meet the ISO holding periods for beneficial tax treatment.

Diversification In Down And Volatile Markets

The need to diversify is a common theme in all investment planning. Do the down markets and volatility of 2022 make that need more or less urgent at year-end?

“I think it really depends on what the client is anchoring to,” offered John Owens. “If they’re anchoring to a stock price that was 80% higher a year ago, it may be hard to get them to sell. But I try to spin it by saying hey, your company’s stock may be down but the broader stock market is also down, so you’re selling something at a discount to buy something at a discount. You’re still getting upside, and it’s a more diversified upside.”

The webinar panelists all said they generally recommend that clients sell RSU shares at vesting as a way to diversify out of company stock. “With our clients, we explain that diversification is something we’re going to recommend in every trading window,” asserted Rebecca Conner. “For RSUs that are vesting and available to sell immediately, we will do that from the get-go. And we’ll have that conversation during the good years as well as the bad years. It’s part of the process. Clients understand that they’re dollar-cost-averaging over a period of time.”

To those who are skeptical about this concept, she points out that loyalties to single stocks can be dangerous allies. For example, after an initial public offering (IPO), “statistically 70% of IPO companies do not get back to their initial high price,” an observation that may help to ease the client away from anchoring on that price.

Private Companies In 2022: Delayed IPOs

John Owens noted the special relevance of multi-year planning in 2022 for employees of private companies which were expecting an IPO this year that was postponed by a year or more due to economic uncertainty or other factors.

“Many clients have had delayed liquidity events this year because the IPO market has dried up,” he explained. “For clients who we now know are going to have huge liquidity events in future years, we’ve actually been looking at accelerating income into this year because their income is lower than we thought it was going to be.” This strategy, he observed, takes advantage of the client’s lower tax rate this year for any income that can be recognized now instead of later, when the rate will be higher at the time of the company’s IPO, acquisition, or other liquidity event.

Ways To Reduce Taxable Income At Year-End

What if you did have a big income spike from stock compensation this year? What are some of the ways in which you can reduce your income on other fronts to keep your 2022 income in a lower tax bracket?

John Barringer mentioned first the need to max out 401(k) plans and, beyond that, perhaps consider a contribution to a nonqualified deferred compensation plan. However, he cautioned, this type of planning should be prospective rather than retrospective. “Before that big income hit happens, we need to know how we’re going to proceed,” he urged. “By the time the event happens, if there wasn’t some planning before, it’s getting close to being too late.”

Rebecca Conner agreed. “A client will come to us with a double-trigger RSU vesting and say ‘How do I minimize taxes?’ Oh, man!” she laughed. “Not very easily. However, we can talk about ways to defer future taxes. Maybe it’s a great time to do a mega-contribution to a 529 college-savings plan for a young child. Maybe it’s time to make choices with investments now to really set you up to defer those kinds of taxes in a bigger picture over multiple years in the future.”

Tax-Loss Harvesting

One popular year-end strategy is tax-loss harvesting: you sell stock at a capital loss that can then be used on your tax return to first offset capital gains and then up to $3,000 of ordinary income. “We’re focusing a lot on tax-loss harvesting, mainly for people with huge first-time capital gains, perhaps $2–3 million payouts,” said John Owens. Rebecca Conner added that her firm is doing the same. “We look at how much a tax loss can really help clients and what we think is justifiable,” she explained. “It may help them for a lot of additional stock sales.”

But not all advisors are big fans of this technique. “I do not oversell the idea of tax-loss harvesting,” said John Barringer. “It’s not going to make a huge difference on your tax return. It’s going to lock in losses that you may or may not regret later. And there’s not a lot of bang for your buck in focusing on this when there are so many other issues to focus on with equity comp.”

If you do seek tax-loss harvesting and plan to repurchase the same stock after selling it at a loss, beware of the rules on wash sales, as I discussed in a recent Forbes.com article: 7 Wash Sale Facts To Know Before Selling Stock For Tax Loss Harvesting.

Year-Start Planning In 2023

Part of year-end planning is also thinking about the coming year. “What new grants do you expect in 2023?” asks John Barringer of his clients. “An ongoing down market may mean a bigger share grant or at least a lower exercise price for stock options.” You should also be aware of stock option grants that are scheduled to expire in 2023, he added, along with what would happen to stock options and RSUs if you were laid off.

John Owens pointed out that now is a great time to enroll in an employee stock purchase plan (ESPP), especially if it has “a good lookback provision for calculating the purchase price.” ESPPs with that feature can be a surprisingly profitable deal in a down market.

Rebecca Conner urges clients to think about employment prospects. “Review job expectations and career goals. If you’re making a move in 2023, consider your total expected income and the impact of any stock options that you may need to exercise when you leave your current job for a new one.”

She and the other panelists also recommend evaluating whether to exercise ISOs early in the new year and hold the shares if the company’s stock price is still depressed but the outlook for the company is good. This can minimize your AMT risk while starting the holding-period clock for the beneficial ISO tax treatment.

Further Resources

The webinar in which these experts spoke, which includes their case studies, is available on demand at the myStockOptions Webinar Channel. The website myStockOptions.com has a comprehensive section on year-end planning, including extensive articles and FAQs. Seek guidance on your specific situation from qualified tax and financial advisors.