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Key Takeaway: If you’ve exercised (or plan to exercise) options in advance of (or after) an IPO, you could be on the hook for a massive tax bill. We can help you minimize or even eliminate that bill with a Charitable Lead Annuity Trust.
We love writing about tax mitigation, mostly because of the affirmation we get every day that our content is resonating with the folks we’re out here to help. It’s especially gratifying when we hear, almost in real time, that one of our posts helped someone solve an immediate problem.
That’s been happening a lot lately: We’ve talked to dozens of startup employees working for companies that have recently had their IPO, and most of them didn’t realize that there was a solution to their (often massive) tax bills sitting right in front of them. Today, we’ll tell you about that solution for a specific (but common) situation.
Sophie joined her company in 2017 and received 20,000 options with a 409a valuation/strike price of about $8. Sophie didn’t exercise right away, partly because she wasn’t certain the company would make it and didn’t want to spend the cash to exercise and pay taxes given that uncertainty.
Since then, the company has taken off, and it recently had its IPO at $120 per share. While this is great for Sophie β she’s up more than $2 million on paper β exercising her shares will leave her in a bit of a tax pickle. When she exercises her shares, she will be receiving “income” in the form of her common stock. This means she will have to pay ordinary income tax rates (around 45%) on the $112 difference between her strike price ($8) and the current stock price ($120).
Exercising her options, in other words, means a hefty tax bill of about $1M β (45% tax rate) * (appreciation of $112 per share) * (20,000 shares). Not an easy pill to swallow, but what can she do, right?
As it turns out, Valur can help Sophie reduce or even eliminate her immediate tax bill with a Charitable Lead Annuity Trust, or CLAT.
A CLAT for unexercised (or recently exercised) options
A CLAT is a trust that allows you to take a massive tax deduction today β up to 100% of your windfall income, thereby reducing that tax bill to $0 β in exchange for future charitable donations.
How did this work for Sophie? She sold her stock β now worth $2.4 million β and put all of the cash proceeds into a CLAT in the same year she exercised her options. We helped her design a donation schedule that would get her the maximum tax deduction β $2.4 million! β spread over the next three years. So instead of owing taxes on $2.4 million of income, she owedβ¦wait for itβ¦$0.
Sophie will end up paying taxes eventually, and she’ll be making a sizable donation to her chosen charity in 25 years. But the benefits of saving that $1 million this year are striking: By reinvesting that money instead of sending it to the government, Sophie could realize an additional $2 million of gains using a CLAT than she would have if she had just sucked it up and paid her tax bill this year. And that’s even after she gets to use $2.9 million to achieve her own philanthropic goals.
It’s worth noting that Sophie chose the maximal CLAT strategy: She put all of her gains into the trust in order to zero out her tax bill this year. But CLATs aren’t one size fits all, and you may decide that you can stomach a smaller tax bill now to retain some additional flexibility. The bottom line is that this strategy can reduce your tax bill today, and it’s up to you by how much.
Timing is key
CLATs work best if you move your cash or other assets into the trust in the same year you realize your big income event. We’re here to help you understand your options, and, using our streamlined trust planning tools, there’s still time to get you to the finish line by the end of the year.
A common question from clients is what assets should you fund a CLAT with. In order of fit:
Check out our next Case Study on CLATs to know more. Access ourΒ CLAT tax calculatorΒ to evaluate your potential return on investment, or schedule aΒ call to meet our teamΒ and share your experience!
We have built a platform to give everyone access to the tax planning tools of the ultra-rich like Mark Zuckerberg (Facebook founder), Phil Knight (Nike founder) and others. Valur makes it simple and seamless for our customers to utilize the tax advantaged structures that are otherwise expensive and inaccessible to build their wealth more efficiently. From picking the best strategy to taking care of all the setup and ongoing overhead, we make take care of it and make it easy.