The Biggest Tax Mistake Tech Professionals Make!
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If you’re a tech professional, you know that your compensation isn’t just about your salary. RSUs, stock options, and ESPPs can significantly boost your earnings, but they also come with complicated tax consequences. Many software engineers, data scientists, and product managers in Silicon Valley and beyond fall into the same trap: failing to plan for the taxes on their equity compensation.
If you are a tech professional interested in learning how we can help you claim your financial independence by investing wisely, minimizing taxes, and maximizing your equity compensation, please book a no-obligation call here.
This mistake can lead to an unexpected and painful tax bill, often running into the tens of thousands of dollars. Worse, it can put you in a higher tax bracket, trigger the Alternative Minimum Tax (AMT), and even leave you over-concentrated in your company’s stock. Watch our quick video guide with smart strategies to know how much and when to sell, and what to do if you work at a private company?
So, how can you avoid this tax pitfall? Let’s break it down.
Why Is This Tax Mistake Costly?
At first glance, stock compensation seems like a great perk. And it is if managed correctly. The problem is that many tech professionals don’t understand when their equity is taxed or how much they’ll owe. Here’s what happens:
1. RSUs Are Taxed Upon Vesting—Not When You Sell
If you have Restricted Stock Units (RSUs), your shares vest on a set schedule. When they do, the IRS considers the value of those shares as taxable income. The tricky part? This tax event happens whether or not you sell the shares.
For example, let’s say your RSUs vest when your company stock is worth $100 per share. If you receive 1,000 RSUs, that’s $100,000 of additional taxable income—even if you don’t sell a single share!
This extra income could:
- Push you into a higher tax bracket
- It causes you to underpay taxes if you don’t adjust your withholdings
- Leave you with a surprise tax bill when you file
The common mistake: Many tech professionals assume they can just hold onto their RSUs and sell later when they need cash. But if you don’t sell right away, you’ll still owe taxes on the value of the shares at vesting, which can create cash flow issues.
2. Exercising Stock Options Can Trigger AMT
If your company offers Incentive Stock Options (ISOs), you may think you can hold them indefinitely and sell later at a higher price. But ISOs come with a tax trap: the Alternative Minimum Tax (AMT).
AMT is a separate tax calculation that ensures high earners pay a minimum amount of tax. When you exercise ISOs, the “spread” (the difference between your exercise price and the stock’s fair market value) is counted as AMT income—even if you don’t sell the shares.
For example, suppose your ISOs have a $10 exercise price, and the stock is now worth $100 per share. If you exercise 1,000 options, that’s a $90,000 “spread” that could push you into AMT.
Many employees don’t realize this until after they file their tax returns, at which point they’re hit with a much larger tax bill than expected.
3. Holding Too Much Company Stock Increases Risk
Another mistake tech professionals make is holding onto their company stock for too long. It’s tempting to keep your shares, especially if your company is growing fast. But this can be dangerous.
Why? Because if too much of your net worth is tied up in one stock, you’re exposed to unnecessary risk.
We’ve seen it happen before:
- A high-earning engineer at a Bay Area startup holds onto all of their RSUs, believing the stock will keep going up.
- The company’s stock price drops 40% after a disappointing earnings report.
- Now, not only do they owe taxes on the original (higher) stock price at vesting, but their shares are worth significantly less.
Diversification is key, yet many tech professionals ignore this until it’s too late.
How to Avoid This Costly Tax Mistake?
The good news? You can avoid these tax headaches with the right planning. Here’s what to do:
1. Estimate Your Tax Liability Before Your RSUs Vest
Don’t wait until tax time to figure out what you owe. Instead, plan ahead:
- Check your vesting schedule and estimate the taxable income from your RSUs.
- Work with a financial advisor to determine if this additional income will push you into a higher bracket.
- Adjust your tax withholdings before vesting to avoid a big tax surprise.
2. Sell RSUs Strategically to Cover Taxes
One of the easiest ways to prevent a tax bill shock is to sell a portion of your RSUs as soon as they vest. This gives you the cash to cover the taxes upfront.
Many companies automatically withhold 22% for federal taxes on RSUs, but if you’re a high earner, this may not be enough. You might need to sell additional shares to cover the true tax liability.
3. Plan ISO Exercises to Minimize AMT
If you have stock options, don’t exercise them without a strategy. Consider:
- Exercising ISOs in smaller amounts over multiple years to stay under the AMT threshold.
- Selling some ISO shares in the same year you exercise to generate cash for taxes.
- Working with a tax professional to model different exercise scenarios.
4. Diversify to Reduce Risk
If your company’s stock makes up more than 15-20% of your total portfolio, it’s time to diversify. Holding too much of one stock—even if it’s your employer—puts your financial future at risk.
Some ways to diversify include:
- Selling a portion of your RSUs each year and reinvesting in a diversified portfolio.
- Using a Donor-Advised Fund (DAF) to donate appreciated shares for a tax deduction.
- Rolling proceeds into tax-efficient investments to balance your overall portfolio.
Don’t Wait Until It’s Too Late!
Many tech professionals only realize they’ve made a tax mistake after they receive an unexpected tax bill. But with proactive planning, you can avoid unnecessary taxes and keep more of your hard-earned money.
If you have RSUs, stock options, or ESPPs and aren’t sure how they impact your taxes, it’s time to talk to a financial advisor. A professional who understands tech professionals and equity compensation can help you create a tax-efficient strategy that works for your unique situation.
Your Next Steps
You work hard for your money so don’t let poor tax planning eat into your earnings. If you want to avoid tax mistakes, reduce risk, and make smarter financial decisions, let’s chat. Schedule a call today!
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