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How To Prepare For A Secondary Sale: Tax Deferral Strategies For Startup Shares

Tax planning for secondaries can take more preparation, but with proper planning we can help you earn an additional $1.4 million on a $500,000 exit

If you are a founder or an early employee, or if you own shares in a hot growth-stage company, you might have the opportunity to sell your shares on the secondary market. Like the sale of any highly appreciated asset, secondaries often come with a massive tax hit that accompanies a big win. And unlike an IPO, secondary opportunities can creep up on you, so it’s a good idea to start planning now.

Why it’s especially important to plan early for a secondary sale

When we get asked when the right time for tax planning is, our answer is that although it’s never too late, there are good reasons to get started early. That’s especially true if you expect a secondary opportunity in the relatively near term.

Why? Because the risks of waiting to start planning are especially acute with secondaries.

If you’re preparing for an IPO, the worst-case scenario is that you wait until after your lockup period to set up a tax-advantaged trust (such as a Charitable Remainder Trust) and sell your shares. Yes there’s some stress involved, but you have control over when you sell, more or less. So as long as the company’s value doesn’t tank in the meantime and you move your shares into a trust before you sell, you can wait to sell until your trust is ready to go. In other words, you’ll be fine.

But things can get hairier with a secondary sale. Opportunities to sell shares can come out of nowhere, and you won’t have much control over when the sale has to happen — especially if you didn’t found the company. Plus, there are some administrative hoops to jump through to move your shares into a trust. As a result, although we can get your trust set up and funded faster than any lawyer, the timing becomes trickier without proper planning.

Bottom line: Get started early to make sure you can take advantage of the tax mitigation tools available to you. (If you did wait a bit too long, though, don’t worry: We have strategies available, including Charitable Lead Annuity Trusts, to help you even if you weren’t able to move your shares into a trust before you sold.)

In this post, we’ll outline the benefits of the Charitable Remainder Trust structure and what the process looks like.

Using a Charitable Remainder Trust to defer secondary sale taxes

The math behind secondary sale tax planning doesn’t look all that different from the numbers when you’re planning for an IPO or a crypto sale, so we’ll keep this example brief.

The assumptions

  • Planning to sell shares for $750,000 that were exercised in March 2020 for a total of $10,000.
  • The sale would not be QSBS eligible (because you haven’t held the shares for at least five years) but it would be subject to the favorable long-term capital gains tax rate (because you have held them for at least a year).
  • New York tax rates: Approximately 36% for long-term gains (23% federal, including the net investment income tax, and 13% state and local, including New York City’s income surcharge).

Selling without a trust

  • Pre-tax profit: $510,000 sale minus $10,000 cost basis = $500,000
  • You owe $180,000 in taxes ($500,000 * 36%)
  • Post-tax profit = $320,000

Selling with a Charitable Remainder Trust

  • Trust sells shares for the same $500,000 profit
  • Because the trust is tax exempt, it pays no taxes at the time of sale, so you get to reinvest the entire $500,000 profit from your secondary sale.
  • You might earn an additional $1.4m after taxes using a lifetime Charitable Remainder Trust versus selling your shares out of your personal account

So you got started early. What happens now?

Say you took our advice and started thinking about a Charitable Remainder Trust (CRT) in plenty of time before your secondary sale. What’s next?

  1. Pick a trust structure. We offer a variety of CRTs to fit your needs, including Lifetime and Term trusts (depending on your ideal time horizon) and NIMCRUTs, Standard CRUTs, and Flip CRUTs (depending on your risk tolerance and how you balance consistency and predictability on the one hand, with maximizing returns on the other).
  2. Set up your trust. This is the easy part. Using our automated platform, you can design and establish your trust in 30 minutes or less.
  3. Transfer your shares to your trust. Because the main benefit of a CRT is deferring the taxes you’d otherwise pay when you sell your shares, you need to get your shares into the trust before you sign an agreement to sell your shares. How easy this will be depends on your company. Every company’s stock and option purchase agreements are different; we’ve seen agreements that allow shareholders absolute freedom to move their stock without anyone’s approval, agreements that allow transfers only with board approval, and everything in between. We’ll help you figure out what you need to do to transfer your shares to your trust so you’re ready to take advantage of tax deferral when the secondary opportunity comes.

The upshot

Tax planning for secondaries can require more planning because of the short timelines of secondary opportunities but with a little planning you can take advantage of a Charitable Remainder Trust to defer taxes on your sale and compound those tax savings over the long term.

Next Steps

Follow up with out next post on how to avoid capital gains taxes on stock sales. Try our calculator, or you can set a time to meet with us!

About Valur

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.