Your private stocks surged after an IPO. Now is the time to consider taxes.
June 2, 2021
4 minutes to read
Opinions expressed by Contractor the contributors are theirs.
2020 was the most active year for initial public offerings (IPOs) since the 1990s, according to FactSet. Nearly 500 IPOs of traditional and special acquisition companies (PSPCs) have raised more than $ 170 billion. Analysis by ICapital Network shows that the market cap of the average unicorn that went public in 2020 was more than double its previous valuation in private markets.
This wave of IPO activity is expected to continue into 2021, and potential gains in share value before or after a company’s IPO can result in windfall profits with significant tax implications for companies. entrepreneurs, leaders and early employees. Selling highly valued stocks could result in you facing substantial capital gains taxes.
One option to help minimize the tax burden is to donate a portion of your shares – during or after the lock-up period – to charity. Many charities accept direct donations of publicly traded stocks and donor-advised funds, which are 501 (c) (3) public charities, typically have the resources and expertise to assess, receive , process and liquidate both publicly traded stocks and private business interests. And by directly contributing to some of these actions, you can not only address some of the tax considerations of an exceptional IPO event, but you can also achieve maximum philanthropic impact on the charities and causes you support.
Related: 4 Ways Charitable Giving Can Help Lower Your Taxes in 2020
There are two tax advantages associated with donating IPO shares. If you itemize the deductions on your return and donate stock, you can claim a charitable fair market value deduction for the tax year in which the donation is made. Plus, you can potentially eliminate the capital gains tax that you would otherwise have had to sell if you sold the shares yourself and gave the proceeds in cash. This can mean up to 20% more that is available to support your favorite charities and causes.
This hypothetical case study with Sarah, an early employee of tech startup ABC, for example, illustrates the benefits. Sarah’s incentive stock options, which she exercised several years ago, have seen significant appreciation since the company’s IPO a few months ago. Now that the lock-in period expires, Sarah plans to donate a portion of her valued stocks to her favorite charities this year.
Image Credit: Schwab Charitable
This hypothetical example is for illustration purposes only. The example does not take into account state or local taxes or the surtax on Medicare net investment income. The tax saving shown is the tax deduction multiplied by the donor’s income tax rate (37% in this example), less long-term capital gains taxes paid.
Option 1, as shown above, imagines Sarah sold the shares, paid federal capital gains taxes, and donated the net proceeds.
In Option 2, Sarah donates her shares directly to a public charity or donor-advised fund. In this scenario, Sarah may be able to eliminate capital gains tax and may be eligible for a tax deduction for the current year for the full fair market value of her shares, leaving her more for charity and greater tax savings.
In addition to the potential tax benefits described above, the following considerations may apply.
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1. Donate long-term held stocks with high appreciation.
Incentive stock options for the given IPO shares must have been held for more than one year from the exercise date and two years from the grant date. Equities should also have appreciated in value to take full advantage of the tax benefits.
2. Avoid pre-arranged sales.
Any arrangement that would require a fund advised by a donor or other public charity to sell the stock upon receipt should be avoided. This type of “arranged sale” may not provide the same tax benefits.
3. Be aware of the lock restrictions.
The issuer’s attorney determines whether and in what manner IPO shares may be donated during a blocking period. Any restriction that materially affects the value of the shares or prevents the shares from being freely traded may require a qualified valuation to justify fair market value, and such restrictions may result in valuation haircuts. Be sure to consult with your company’s legal counsel and the donor advised fund or other public charity when donating IPO shares.
Related: Here are the top ten IPOs to watch in 2021
4. Determine if the legend and affiliate restrictions in rule 144 apply.
If the IPO shares are restricted by a caption or held by an officer, director or shareholder at 10%, the general counsel of the company must authorize the donation of the shares. Generally, restricted shares must be sold in accordance with Rule 144 of the Securities Act.
Review this infographics to learn more about donating IPO stocks and other valued non-cash assets to potentially maximize your tax savings and impact on favorite charities.