My wife and I are receiving a large amount of money from employer stock options; how can we lower our tax bill?
My wife and I are about to receive around $200,000 to $250,000 in a few months through cashing out an options plan from our employer. The money is going to be given to us through payroll. What options do we have to lower our tax bill? My wife has a 401(k) and I am thinking about opening an IRA, but I do not know how beneficial it would be for tax purposes. We are also planning to open a 529 plan for our daughter's education.
Based on your information, the three strategies to begin exploring are maxing out your 401(k) plans, maxing out an HSA if you have access to one, and creating a Donor Advised Fund if you are charitably inclined. There are other strategies you can use, but they require a lot more information about your personal situation.
Maxing out your wife's 401(k) is definitely an option for reducing your tax bill, although that will only equate to $18,500 in the current year. You could also max out the contribution to a Health Savings Account (HSA) to reduce your taxes if your family has a High Deductible Health Plan. If you regularly donate to a charity, you could also create a donor advised fund to pre-fund the future years’ charitable contributions and take the deduction in the current year to offset the tax liability.
An IRA unfortunately won't help for this year's tax bill, as, based on your circumstances, you will be above the threshold for contributing to an IRA and taking a tax deduction. Even still, you should consider contributing the max to the IRA as you can potentially convert it to a ROTH and enjoy the tax benefits in retirement. A ROTH conversion, however, could have other tax implications based on your unique circumstances and what you other retirement accounts are set up as.
Similarly, a 529 plan contribution isn't going to be tax deductible for federal tax purposes – but funding the 529 plan is a great way to use this stock bonus to avoid future expenses.
If you haven't executed the order yet, you should talk with a financial advisor to see if there are specific ways you can reduce the taxes you owe based on the details of the stock options. For example, if the stock options are qualified Incentive Stock Options (ISO), you might be able to enjoy much lower capital gains tax treatment on the profits rather than the higher income tax treatment. This could save tens of thousands of dollars in taxes, but only if you are selling the ISO stocks more than 2 years after you received the options and more than 1 year after exercising the options.
If you don't have a fee-only and fiduciary financial advisor, now would be the time to get one. The tax impact of making the wrong decision here could be significant. You should also talk with your tax advisor about the tax implications for next year's filing.
Be careful about the financial advisor you seek out, as many are commissioned product salespeople (hence the fee-only and fiduciary advisor). If the advisor suggests you put a significant amount of the money into a life insurance contract, an annuity, or any investment which is illiquid or has surrender charges; you may want to find a different advisor. The advisor will talk about the tax benefits, but the policies will give you $0 in tax benefits this year (and come with higher costs and lower returns than alternatives).