What Happens to Employees When a Company Goes Public?

As you’ve probably seen, there’s a wave of tech companies with hotly anticipated Initial Public Offering (IPO) announcements expected this year which could have the effect of creating thousands of millionaires overnight and countless more who’ll see their financial situation change after their company goes public.

An IPO is a big moment for many stakeholders in a company, including its own employees. When a company goes public, many employees get a major income boost because they may be given Restricted Stock Units as part of the company’s incentive plan. While it’s a very exciting time for these employees, the tax implications of this newfound cash could surprise them.

Companies like Lyft and Uber plan to also distribute bonuses to drivers who’ve completed a certain number of rides to help them participate in the IPO since they’re classified as independent contractors and not employees, so they’ll receive bonuses which can be used to purchase shares but they won’t receive Restricted Stock Units as part of the public offering. However, these bonuses may also come with a holiday bonus tax.

Following Lyft’s IPO announcement today you may be wondering what the tax implications are if you’re lucky enough to work as an employee or contract with a start up that goes public. Here is some information to help you understand the tax implications of stocks or bonuses you receive through an initial public offering.

Restricted Stock Units (RSU) from your employer are a promise to grant shares of stock, which are granted on a vesting schedule or meeting of certain milestones by you or your company. When vesting occurs, the value of the stock is considered ordinary income valued based on the Fair Market Value (FMV) and the employer is required to withhold taxes as soon as the RSUs are issued, whether you sell your shares or not. It’s good to make note of the value when the RSU vests, because it is necessary to calculate the proper capital gains if the employee sells the stock later. If you later sell the shares, the change in value is a capital gain or capital loss, which also have tax implications, including capital gains tax.

RSUs are not the only way you can own stock in your company. Employee Stock Purchase Plans (ESPP) are shares that you buy at a discount, so you don’t have to pay taxes until you sell the stock.  When you sell the stock, the discount you received when you bought the stock is generally considered additional compensation to you and will be taxed as regular income. If you sell your stock in less than one year, your gains will be considered compensation and taxed as ordinary income. However, if you sell your shares after one year, your profit will be taxed at the lower capital gains rate.

If you are lucky enough to garner some unexpected income through RSUs, you may be subject to higher taxes than under an ESPP. Either way, stock options give you a chance to make more than your salary, and they also give you a sense of ownership in the company.

RSUs and ESPPs are also still a great investment! With the new tax law changes you may even fall in the zero capital gains tax rate when you sell them. Qualifying income up to $38,600 has a 0% Capital gain rate.

If you are a contractor and received a bonus in an IPO you will have taxes withheld when you receive the bonus in general using the percentage method, which uses a flat percentage rate to figure out the withholding since it is considered to be supplemental income.  Under the new tax law, the federal tax rate for withholding on a bonus was lowered to 22%, down from the federal income tax rate of 25%.

Your employer also has the option to aggregate your bonus with your regular paycheck and withhold taxes based on the whole amount, which likely will result in even higher withholding than 22%. But don’t worry, the money may not be lost. Since tax rates on supplemental income may be higher than your actual tax rate based on your total income when you file at tax time, you may get some of it back as part of your federal tax refund when you file your taxes.

Have you ever received employee stock options? What type were they?

Don’t worry about understanding the tax rules regarding stocks and bonds when you start investing. TurboTax will ask simple questions about you and give you the tax deductions and credits you are eligible for.  If you have questions you can connect live via one-way video to a TurboTax Live CPA or Enrolled Agent with an average 15 years experience to get your tax questions answered from the comfort of your home.  TurboTax Live CPAs and Enrolled Agents are available in English and Spanish and can review, sign, and file your tax return.