IPO Abroad: What's Complex about it and how a CPA can help
We’ve often encountered the mindset that because someone works at a company, they have a better pulse of the stock price than the broader market participants. This may be true to some degree, but there are also biases, like the endowment effect, that cause us to irrationally place a higher-than-market value on something we own (you can find good examples of the endowment effect on Craigslist any day). Another message we’ve heard is that technology is the way of the future, so why shouldn’t someone maintain their investment? We definitely agree that technology is changing the way we live, but we also acknowledge that stock prices are reflective of the market’s perception of future growth. In a study of our client base, we reviewed the year-to-date price performance of all of the publicly traded companies that our clients work for and receive stock compensation in. During 2021, the average stock price went up 15% (with a median of 12%). If we compare this to the broader market, the S&P 500 was up 27% and the Nasdaq (often thought of as the tech index) was up 22%, therefore on average the individual stocks were trailing the indices. Second, the range of the performance outcomes was staggering, with the highest performing stock at +109% and lowest at -49%. Of the securities, 38% had negative returns for the year. A skeptic might say that this is a sampling bias based on Mana’s client base, but Nasdaq index constituents showed the same qualities. As Art Holly from Breacher Capital writes, “Without the fabled 5, the Nasdaq Composite would be down more than 20%! Initially I was skeptical about this data...over 33% of stocks in the Nasdaq Composite are down over 50% from their highs and over 60% are down over 20%.” If you don’t want your net worth to swing with the same volatility as we’re describing, this points to the case for diversification.
If you’re working for a private company that is planning to go public, this moment of entry into the public markets may be one of the most important days of your financial life. There are many considerations to be made with this new found liquidity, most specifically, how much stock should I sell and when?
If you work for a global company with international headquarters, you may find yourself going public on a foreign exchange, and this can get even more complicated. Ernst and Young reported in December 2021 that global markets experienced overall increases by both IPO volume and proceeds, with Europe, Middle East, India and Africa (EMEIA) exchanges producing the highest growth, a 158% increase by number and 214% increase by proceeds (724 IPOs raising US$109.4b).
In today’s blog, we are going to delve into the additional considerations for you to make as an employee of a company that is going public abroad.
Even without any international considerations, stock compensation packages can appear to be a dizzying tangle of alphabet soup (RSUs, NQSOs, ISOs, ESPPs, etc.). To determine when income is recognized and the type of income received (i.e. capital gain or ordinary income), an employee needs a firm understanding of the type of stock compensation they are entitled to and an understanding of the tax consequences related to that particular type of compensation. For example, restricted stock grants (RSUs), currently a popular compensation method for tech firms like Google and Facebook, usually contain a vesting schedule. Upon vesting the employee will recognize ordinary income (i.e. additional wage income) equal to the value of the shares vested. Non-Qualified (Non-Statutory) Options (NQSOs), give the employee the option to purchase shares at a fixed price by a certain price. NQSO plans often also have vesting schedules, which implement certain requirements (most often a time period) which must be satisfied before the option can be exercised. There would not be any taxable income to the employee upon vesting of an NQSO, but instead, the employee will recognize ordinary income equal to the difference between the exercise price paid and the fair market value of the stock when exercised. Incentive Stock Options (ISOs) and Employee Stock Purchase Plans (ESPPs) are other common types of stock compensation, which have more complex tax characteristics and may result in ordinary income, capital gains (often qualifying for preferential tax rates), or a mix of ordinary and capital gain income. Understanding the type of stock compensation package an employee is enrolled in is an important first step to understanding the potential tax and investment strategies related to shares of a company going public.
Pre-IPO companies may utilize a double trigger vesting to attract employees and lessen the tax burden while the stock is illiquid. Using the recent IPO of Airbnb as an example, many employees received stock compensation packages with double trigger vesting requirements. As with most vesting conditions, there was a time requirement. For example, an employee with RSUs would vest the RSUs over a period of time, such as 4 years, with a certain number of shares released throughout that period based on the vesting schedule. Airbnb also utilized a double trigger, which introduced a second liquidity condition to complete vesting. Liquidity conditions often require certain transactions or events to occur, such as a change of control (sale) of the company or IPO, in order for vesting to complete for the employees. This benefits employees because if the shares had been vesting while they were illiquid, the employees could recognize considerable taxable income without the ability to sell shares to cover their tax liability. In the Airbnb example, employees with double trigger RSUs recognized the income from the RSUs, some of which had satisfied the first vesting condition years earlier, upon the IPO of Airbnb. This timing of the income recognition with the IPO resulted in significant transfers of shares to employees upon IPO and allowed the employees to sell share after the IPO to pay their tax liability. When a company is anticipated to go public, whether domestic or abroad, employees with stock compensation packages should take some time to review the details of their compensation package to see what impact the IPO may have on their stock compensation.
Employees receiving stock compensation related to a company going public abroad can have additional tax complications. What is the result if an employee receives stock compensation from a foreign company and no income is recognized upon receipt of the shares in the country where the foreign company is based? U.S. tax law must still be evaluated if the employee is subject to income taxes in the U.S. Often, we have seen stock compensation plans issued by foreign employers result in income recognition using the NQSO rules and the employee should recognize ordinary income (i.e. wages) at the time of exercise. This is true even if there is no income required to be recognized in the country of the foreign employer who issued the stock. Depending on how the individual is employed, this income may or may not be included in gross wages reported on a Form W-2.
A critical issue also is that employees who work both in the U.S. and abroad during the vesting period of their stock-based compensation may have a requirement to pay tax and file returns in both the U.S. and in a foreign country. Careful consideration and planning should be done with the employee’s CPA in order to mitigate the potential double taxation that might occur in this fact pattern through the use of several potential exclusions and credits contained in the Tax Code.
Selling stock that is traded in a foreign currency may result in a surprising tax result. For example, assume an individual holds stock with a cost basis of 10,000 EUR that was acquired when 1 EUR equals 1.15 U.S. dollars. If that individual later sells that stock for 10,000 EUR when 1 EUR equals 1.20 dollars, you may assume there is no taxable gain/loss as the sales proceeds equal the cost basis. However, foreign currency fluctuations may result in a gain or loss as the cost basis and sales price must be converted to U.S. dollar using the spot rates on the transaction dates prior to calculating the gain/loss. In the situation presented here, there would be a $500 capital gain. When an employee receives stock from a company going public on a foreign exchange or an investor invests in an international IPO, determining the appropriate cost basis and date acquired for determining the appropriate spot exchange rate will depend on how the stock was acquired (i.e. purchase, NQSO, etc.).
An often-overlooked issue by those holding non-U.S. assets, is the potential disclosure requirements. For example, imagine an employee who worked for a company that has an IPO in Hong Kong. If that employee holds stock in the company in a foreign brokerage account, it may trigger disclosure requirements. The Report of Foreign Bank and Financial Accounts (FinCEN 114) is a reporting required by a U.S. person that has a financial interest or signature authority over foreign financial accounts if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. This easy-to-miss filing requirement can cause massive headaches to U.S. persons if ignored. Even if there was no under-reporting of income linked to foreign accounts, failure to disclose this type of account can result in a penalty of $10,000 per violation. Imagine the surprise of receiving a $10,000 bill from the IRS when you had paid all of your taxes but forgot to inform them of every single foreign financial account you held! There is a similar disclosure required on a Statement of Specified Foreign Financial Assets (Form 8938). Like the FinCEN 114, a U.S. person holding foreign financial assets may need to disclose these assets on a Form 8938. This form can include assets other than financial accounts, such as stock held directly (i.e. holding a stock certificate), and has a different threshold for filing based on the filing status of the person, whether they live in the U.S. or not, and the value of the assets. The Internal Revenue Service (IRS) can also impose a $10,000 penalty for failure to file the Form 8938 or making a mistake on the form. Other more complex disclosure requirements may also be required for ownership of foreign entities depending on the ownership percentage and type of business conducted. The intensive scrutiny by the IRS on international assets combined with the lack of common knowledge of these requirements is a dangerous combination that can trap employees receiving stock through a foreign IPO in a costly battle with the IRS.
As you can see, IPOs on foreign exchanges are complicated! We highly recommend working with a qualified CPA who has expertise in international taxation to evaluate the tax implications, and a financial planner with a CFP® or CFA® to help you evaluate the investment and better understand how your newly public company stock aligns with your goals for your future.
Disclosures: An Index cannot be purchased directly by investors. Past performance is no guarantee of future results. Indexes do not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Source: Performance calculated using Total Return for 2021 on Y-Charts.
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This post was co-authored by Stephanie Bucko & Tyler Dixon.
Tyler Dixon is a senior manager at Spott, Lucey & Wall, Inc. CPAs, specializing in accounting and compliance services provided to various businesses including multi-state professional service corporations, closely held corporations, foreign corporations, limited liability companies, and partnerships.
Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.