What do I need to do, tax-wise, for a sudden windfall?

Question

I had stock options in a company which was recently sold to a private investment firm. As a result, my options were converted into a single large sum ( > $100,000) and delivered via wire transfer into my banking account.

This is a staggering amount of money for me. I have no debt outside my mortgage, so the plan was to just roll this in with the rest of my investments.

That said, I would be flabbergasted if there wasn't some tax thing I needed to do to account for this influx of cash. I did get an explanatory letter from the company's CFO which noted that the proceeds from the sale may qualify as long-term capital gains (I received the stock options > 2 years ago).

Feeling a little overwhelmed -- what next?

Follow Up:

I have spoken with a CPA, and have learned a few things:

• I did not have stock options, I had actual stock, so there was no need to exercise.
• As long as I withhold 110% of my previous year's tax burden, safe harbor laws mean I won't be penalized for not paying estimated taxes.
• In my case, this does qualify as long-term captial gains.

Speaking to a tax professional was the correct play.

Answer 1

In this case you should consult an actual tax professional since that can be rather complicated.

In general

1. Tax treatment depends on whether (and how long) you did own actual stock at any point or if your options were directly converted to cash in a "same day sale".
2. Assuming it's a "Same day sale" then the profit (sell price - exercise price) is taxable as "ordinary income". Same as your paycheck.
3. You will need to pay "estimated taxes" this quarter to avoid an "underpayment penalty" next April
4. You may want to check your withholding or estimated tax for previous quarters. If the windfall triggers certain "phase out" provisions you may be subject to underpayment penalty. However, with the new Trump tax laws that is very unlikely.
5. You may want to adjust your withholding for the rest of the year to make sure you don't underpay in these quarters either.

You can certainly calculate all this yourself, but in this case, having a pro do it may easily save you more money then you need to pay for the service and you are on the safe side.

If you did own actual stock (not just options), things are significantly more complicated.

EDIT: rephrased bullet 4 since it was poorly worded

Answer 2

In addition to other answers: this might be a good year to change your 401k, IRA and HSA contributions to IRS-allowed maximum. To make sure that some part your income goes into tax-protected accounts.

Answer 3

Yes find a tax professional to provide an estimate of how the windfall will impact your taxes. They will know if it is short-term or long term capital gains.

What I want to talk about is the topic of quarterly taxes.

Those are not a concern for you this year. Many of the answers are telling you to make sure that you pay the quarterly taxes and even implying that of the windfall is high enough it could impact previous quarters. Nonsense.

Your situation is the perfect situation for taking advantage of the safe harbor for withholding. You just have to make sure that the withholding from your regular job meets the safe harbor level.

From IRS PUB 505 (2019):

General Rule

In most cases, you must pay estimated tax for 2019 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2019, after subtracting your withholding and refundable credits.

2. You expect your withholding and refundable credits to be less than the smaller of:

   a. 90% of the tax to be shown on your 2019 tax return, or

   b. 100% of the tax shown on your 2018 tax return. Your 2018 tax return must cover all 12 months.

Note. The percentages in (2a) or (2b) just listed may be different if you are a farmer, fisherman, or higher income taxpayer. See Special Rules , later.

Regarding higher income:

Higher Income Taxpayers

If your AGI for 2018 was more than $150,000 ($75,000 if your filing status for 2019 is married filing a separate return), substitute 110% for 100% in (2b) under General Rule , later.

For 2018, AGI is the amount shown on Form 1040, line 7.

You may need to modify your W-4 allowances to make sure that you have 100% of your taxes for the previous year withheld, but making that safe harbor specified in 2B above will allow you to legally delay paying the bulk of the extra taxes owed until the spring of 2020.

I have used this safe harbor provision several times.

Answer 4

"my options were converted into a single large sum"

You are probably leaving out some important details and it is critical that you either get them correct or hire someone to do it for you. What you described is usually a two step process, and I will include some additional steps:

1. options are granted. Usually your stock price is locked in at grant time.
2. options vest. This means you have the right to exercise the option. Some people do not exercise as soon as the stock vests if they believe the stock will continue to appreciate in value and they don't need the money right away.
3. vested options are exercised and turned into stock. Depending on the type of option you have, this may or may not be a taxable event. What matters is whether your options were ISO or NSO.
4. stock is sold and turned into money. This is always a taxable event but the time interval between exercise and sale affects the type and amount of tax you pay.
5. quarterly estimated tax is owed. The IRS wants to see you keep up with your tax obligations. For most W2 taxpayers, this happens automatically with your paycheck. But events such as stock sales are your responsibility with regard to taxes.

Answer 5

This is going to be considered income, so sock a portion of it away for taxes!

The question then is, "how much should you sock away?"

That depends on how long you've held the options.

• If less than a year, then it's short-term capital gains and so will be added to your income, so you'll be boosted into a higher bracket. Estimate what that will be based on your current income, and then put away that percentage of the $100K for taxes.
• If more than a year, then it's long-term cap gains. Thus, put away 20% for taxes.

These "put away estimates" might be too high (you might have put too much in a high yield savings account), but better too much than too little.

Another issue is that you might need to pay quarterly taxes on the windfall. I'll leave it to others to answer that.

Answer 6

Yes. There's a big thing you've got to do!

You need to go get the document that the check came with and search it for "Withholding". You need to know if they withheld taxes for State and Federal. Commonly, on a stock option execution like this, they do a flat 25% withholding. But you need to know for sure.

Do a "dry run" on your taxes to spot big problems

And if everything I say below is "blah blah Ginger" to you, then talk to your tax advisor. If your tax advisor is TurboTax, take it to a better tax advisor.

We're not doing fine numbers here, so you can just use 2018 forms and instructions. Our goal here is to figure coarsely what your ultimate taxes will be, and see if enough money has been withheld; and if not, correct that.

I'd expect it to go pretty quick with the new Trump postcard forms, the main thing that's new is figuring out the correct tax treatment (category) for the lump sum.

Remember: Don't put the value of the check you got as income -- you have to use the "gross income" and "withholding" numbers off the paperwork that came with the check. So for instance if the check was $100,000, the gross income was $135,000 and the Fed withholding was $30,000 and state $5000, you have to use the $135,000 number on the "income" side of your 1040.

For your regular salary, use last year's if you don't expect it to change much, or if you know how much it changed by percentage, just fudge upward all the numbers: gross income, tax withheld etc. We are not after perfection today.

Finally at the bottom of this "straw 1040" you'll have "Tax." And "Taxes withheld" (both from salary and from this big cash-out). What's the difference? Will you owe money or be owed a refund?

• If you're owed a refund, don't worry about it.
• If you're owed a HUGE refund, ask another question about adjusting your withholding.
• If you owe less than, say, about 5%, don't worry about it.
• If you owe more than 5%, then whatever that difference is that we came up with in our rough draft here, you should make an estimated tax payment. You do those on Form 1040-ES.

This isn't precision work here; we're using last years' forms for Pete's sake; we only need to get in the ballpark.

If you owe enough to the Feds to justify sending a check, then you should do the same above procedure for State (or county/city) taxes, because you may owe them estimated payments also.

IRS requires that you pay your taxes throughout the year roughly when you earn them. For instance I got a huge windfall in December, and I made an estimated tax payment in December. They were satisfied by that because the income came in December. When you fail to do that, and pay a large fraction of your taxes on April 15, they have penalties for that.

Remember, in 2020 when actually filing your 2019 taxes, to include this estimated tax payment inside your "withholding and payments" area of your tax form. If you mess this up, IRS will fix it for you.

Answer 7

That said, I would be flabbergasted if there wasn't some tax thing I needed to do to account for this

The stock option agreement you signed told you that taxes are your own responsibility. These transactions are just different than wage work even though your employer happens to be involved there is no withholding obligation from them.

Your CFO was correct, it MAY be long term capital gains, as in MIGHT. It MAY be income. It depends on the kind of contract (NSO, ISO, something non-standardized), and it depends on what you did when you received them like make an 83(b) election with the IRS or an 83(i) election with the IRS, or nothing. It depends on whether this transaction that was ultimately going to convey equity ownership for you was actually an OPTION or an EQUITY grant. If it was an equity grant it depends on if it was an RSU or RSA or something non-standardized or something else. In either scenario it depends on the share price of the conversion to cash payout.

When your CFO said it "may" be long term capital gains, its because it is the most favorable outcome tax wise and other employees in your company were on top of this strategically doing all of the aforementioned elections depending on their specific preferences and goals when they got their stock options. If you were one of those people, then it is just welcome news that the CFO reassured you of. Your CFO doesn't know exactly what you did or didn't do.

Answer 8

You need to figure out how much this is going to affect your taxes. I agree with others that you need a tax professional. In the immediate term, you could probably get away with just paying $30,000 (30% of the windfall) as estimated tax. I believe that June goes in the third quarter and is due September 15th. But I think that you can be more precise and withhold less if you consult a tax professional.

In a comment, you asked

Any suggestions on how to find a tax professional in my area? Am I looking for a CPA, an EA, or something else?

A CPA (certified public accountant) is for corporations. They are state certified as professional accountants who can do the quarterly audit of your corporation. You don't mention having a corporation, so you don't really need a CPA.

An EA (enrolled agent) is IRS certified, including for individuals. This is more like what you need. But there's another aspect. Whether you are getting income or a capital gain depends on the exact contract through which you got the stock options.

The kind of person who tells you the tax implications of a contract is called a tax lawyer. You can call your local bar association and ask for a recommendation for a tax lawyer with knowledge of stocks options received by an individual. This person should be able to tell you how much additional tax you would have paid if you received the windfall last year. If you withhold that much, it should cover you for this year. The big question is if you pay tax on income or capital gains and in what bracket.

Answer 9

More of an idea but... Probably a slight unorthodox approach, but if you have any ambition of setting up a private company, you could technically put the money into the company. I'm sure there will still form of tax cut, just purely because it was sent to you personally, so some form of personal tax liability I would assume.

But it would be strong if you could get some return on the money, a business could be a viable option if you feel up for the learning involved etc.