RSU Taxation for pre-ipo companies
I have never worked for pre-IPO companies, hence do not know RSU taxation concepts.
Here is my understanding based on an example I have shown below. Please let me know if I am correct.
Offer - 200K Cash + 150K RSU per year = 350K TC
Year 1 - 200K Cash + 200K RSU (valuation increased in the first year while vesting). Since the company is not IPO yet, W2 will still show 200K, the 200K RSU will be taxed upon a liquidity event.
Year 2 - 200K Cash + 250K RSU (valuation increased in the second year). The company is still not IPO, so W2 will still show 200K.
The company goes IPO during the third year. Valuation has increased and the year 1 + year 2 RSU is now worth 600K on the first day of trading. RSUs now get taxed since a liquidity event has taken place.
Year 3 - 200K Cash + 350K RSU (stock is going up after IPO).
My understanding is that W2 for the third year will be 200K Cash + 350K RSU (vested during the third year) + 600K RSU (year 1 + year 2) = 1.15M
It seems to me that on the year the company goes IPO, employees get screwed big time on taxes since they will be taxed at the highest rate possible. In a publicly-traded company, RSUs would be taxed in year 1, year 2, etc evenly. This is not exactly bad since the employee has made a lot of money, but it seems they will end up paying higher taxes compared to if RSUs were taxed evenly every year.
Is my understanding correct, or am I missing something? I have tagged Chime and Plaid since they are the current hot pre-IPO companies.
comments
The default one falls under section 83(a) of the tax code. You will, by default, be taxed on your RSUs when they vest. They're income (granted to you in exchange for performance of services), so you'll be taxed on them at ordinary income rates. Usually this will be done automatically, by removing shares from your grant to pay for the taxes. I believe secondary markets do this too, based on the latest 409(a) valuation of the company's common shares, but I am not sure of that.
Any additional increase in the share price from the time of vest to the time of sale will be treated as a capital gain, or decrease as a capital loss. This includes selling shares on a secondary marketplace. Plenty of info on how capital gains tax works out there if you need it.
You can also file a section 83(b) election within 30 days of your grant. By doing this, you are electing to pay the tax on part or all of your grant at the time of grant rather than the time of vest. This carries some risks (since your shares are not liquid, you can end up being unable to pay for them, and if the price moves down after grant you will overpay), hence why it isn't the default tax treatment. But if you believe the price is likely to appreciate significantly from grant to vest and you have some extra money to pay the tax lying around, it may be worth looking into.