Equity compensation has become an increasingly popular way for employers to reward top talent. Indeed, last year, 72% of companies surveyed claimed that offering equity compensation gives them a competitive edge in hiring.
Of course, this means employees are left to figure out what to do with their equity on their own.
What are vesting schedules? How much tax will I pay? Should I rebalance my portfolio? These are high-value questions with potentially huge implications for your client’s long-term wealth. This is where you come in.
As an advisor, you can help equity-compensated clients incorporate these complex scenarios into their portfolios, ensure they’re able to keep as much after-tax profit as possible and plan for their future. By doing so, you’ll not only gain trust and lay the foundation for a valuable long-term relationship, but you’ll also have the opportunity to grow your assets under management.
In this article, we’ll break down how advisors can support clients with complex equity compensation scenarios.
A quick primer on equity compensation
While working with clients who accept equity as part of their compensation, you’ll see different types of stock or equity derivatives based on their employer, like:
- Stock options (ISOs and NSOs): the preferred equity structure offered by high-growth startups
- Restricted stock units (RSUs): typically granted to employees at large, publicly traded companies
- Employee stock purchase plans (ESPPs): common across established industries
Each type of compensation will be granted to employees and accompanied by various forms of documentation, such as a grant notice, equity award agreement, or equity incentive plan, explaining the details of the award.
Now, equity is different than standard income in that most equity cannot be sold as soon as it’s granted to an employee. Instead, it’s based on a promise: an employee is entitled to equity under certain conditions, subject to a vesting schedule. Read more about those here.
How you can help your clients retain their profits
If they’re not careful, your clients can find themselves footing a large tax bill for their vested equity. This can seriously harm their financial savings, so pay close attention to their tax liability, which will keep earnings in your clients’ pocket, and not Uncle Sam’s.
Timing and tax brackets: Exercising stock options or receiving vested shares in a high-income year can magnify your client’s tax liability. By strategically timing exercises and sales you can reduce their overall tax burden.
83(b) elections: For certain types of equity awards, the 83(b) election allows the recipient to pay taxes on the value of the shares at the time of granting rather than upon vesting, potentially delivering significant tax savings. However, if the price falls or the shares never vest, your client could end up overpaying or losing money. Advisors should ensure clients fully understand the risks before making an 83(b) election. Note: this election must be filed with the IRS within thirty days of the equity grant date.
Alternative minimum tax (AMT): AMT can catch stock option holders by surprise if they hold shares after exercising. Staying ahead of AMT calculations—and working with a licensed CPA if necessary—helps clients plan for potential tax liabilities. This might mean selling some shares in the same calendar year as the exercise or setting aside funds to cover any additional taxes owed.
State and local tax implications: Clients living or working in high-tax states (or multiple states in a given year) may face added complexities. If your client exercises or sells shares while residing in different jurisdictions, the tax calculations can become even more intricate. Looping in a tax expert can help you handle these complex tax needs.
Mitigating concentration risk in client portfolios
We’ve all seen the headlines: thanks to Nvidia’s equity compensation package and the rise in its stock price, 76% of the company’s employees are millionaires. This is a historic positive outcome, but it also introduces meaningful concentration risk.
Diversifying, on the other hand, will lower your client’s concentration risk. A 10b5-1 plan for public company executives, for example—or taking advantage of secondaries (if allowed) the next time your client’s startup raises a venture round—can protect them from the boom and bust of a highly concentrated portfolio. In the meantime, evaluate the remainder of your client’s portfolio and consider allocating it to complementary assets in order to balance their concentrated equity position.
Including equity compensation in estate plans
Estate planning is an essential tool for your clients: the right strategy will help them retain as much of their earnings as possible, and incorporate those earnings into long-term financial plans. It may be best for your client to transfer shares into a trust before those shares appreciate further, or employ certain tax-efficient gifting strategies to help shift wealth to their children. Decisions like these are where your advice will be extremely valuable.
Employees can also use their equity payouts to donate assets to a donor-advised fund or charitable organization, which are tax-efficient contributions. Strategies like these will help your clients achieve their long-term financial goals and lay the foundation for trusting long-term client relationships.
Why servicing this client base can benefit your practice
Equity-compensated clients have significant economic upside as a result of their compensation packages. As their equity is realized and their wealth increases, you will grow with them. Taking a bet on these clients early on may bring difficult tax, liquidity, and portfolio management decisions, but will pay off in the long run as their portfolio and your assets under management grow over time.
