When Your Startup Is Acquired: How Your Equity Is Taxed

The short version

• Cash is taxed this year. Stock you swap for the buyer's stock in a qualifying merger usually isn't taxed until you sell it.
• Escrow (money held back for a while) is usually taxed when it's paid to you, not on the closing day.
• What you hold matters. Shares you own get capital gains treatment. RSUs and options that are paid out in cash are taxed like wages.
• Nothing is withheld on share sales. If you're paid cash for shares you own, plan to make an estimated tax payment.

Step 1: Find out how the deal pays

Your company will send deal documents, often called an information statement or merger proxy. Look for three things:

1. The mix: how much is paid in cash and how much in the buyer's stock.
2. Escrow or holdback: the share of the price held back, usually 10% to 15% for 12 to 18 months.
3. Earnouts: extra money paid only if the business hits goals after closing.

Shares you already own

This covers common stock you bought, got from exercising options, or kept after RSUs settled.

All-cash deals

It's a sale. Your gain is the price minus your cost (your basis). It's long-term if you held the shares more than one year, and short-term otherwise.

Stock-for-stock deals

Many mergers are set up as a tax-free reorganization. If yours is, swapping your shares for the buyer's shares isn't taxed. Your original cost and holding period carry over to the new shares, and you pay tax when you sell them.

Not every stock deal qualifies. The deal documents should say whether it's expected to be tax-free.

Mixed cash-and-stock deals

In a qualifying merger that pays part cash, the cash is called boot. You're taxed on the smaller of:

• your total gain, or
• the cash you receive.

Example: You own 8,000 shares with an $8,000 cost. The deal is worth $100,000 to you: $40,000 cash and $60,000 of buyer stock. Your total gain is $92,000. You're taxed on $40,000 now, the cash. The other $52,000 of gain waits until you sell the buyer stock.

The calculator uses a simpler estimate: it taxes your gain in proportion to the cash share. That's usually lower than the rule above when your gain is large, so treat it as a starting point.

RSUs

• Vested RSUs you've already received are just shares. Follow the rules above.
• Unvested RSUs are usually either converted into the buyer's RSUs on the same schedule, or cashed out. Converted RSUs aren't taxed until they vest. Cashed-out RSUs are wages, taxed and withheld like a bonus.
• Double-trigger RSUs at a private company often settle at the acquisition, because it counts as the second trigger. That's wages, all at once, with the usual withholding gap. See The RSU withholding gap.
• Acceleration: some grants vest early when the company is sold, especially if you're let go afterward. Accelerated RSUs are wages when they vest.

Stock options

Options you haven't exercised are usually handled one of three ways.

Cashed out

You get the deal price minus your strike price, in cash. This is wages for both NSOs and ISOs, because you never owned the shares. For ISOs, that means the special ISO treatment is lost, and Social Security and Medicare apply.

Converted into the buyer's options

The buyer swaps your options for its own, adjusted so the value stays the same. Done correctly, this isn't taxed, and ISOs keep their ISO status.

Cancelled

Underwater options, where the strike price is above the deal price, are often cancelled for nothing.

If you're offered the chance to exercise before closing, remember that ISO shares sold in the deal less than 1 year after exercise are a disqualifying disposition: the spread becomes ordinary income. See How ISOs are taxed.

Escrow and earnouts

For shares you owned, money paid later is usually reported under the installment method: you pay tax on it in the year you receive it. If part of the escrow is never paid, you never pay tax on that part.

For RSU or option payouts, delayed money is wages when it's paid, with withholding at that time.

Don't spend escrow before it's released. Buyers do sometimes keep part of it.

QSBS can still apply

If your shares qualified as QSBS, swapping them for buyer stock in a tax-free merger can carry QSBS status over, but only up to the gain that existed at the swap. Gain after that point generally doesn't qualify. See QSBS (Section 1202).

Big payouts for executives

If you're an officer or a large owner, very large deal-related payments can be excess parachute payments. That adds a 20% tax on top of regular tax, and the company loses its deduction. Your company should tell you if this applies.

Paying the tax

• Cash for shares: no withholding. Make an estimated payment for the quarter the deal closes. See Estimated taxes and safe harbor.
• Cash for RSUs and options: withheld like a bonus, usually 22% federal, 37% above $1 million. That's often too little for high earners.
• State tax: cash and wage payouts are taxed by your state, and possibly by states you worked in while the grant vested. See Moving states.

Model your deal

In the calculator, choose Acquisition as your event and enter the cash share and escrow share from your deal documents. You'll see what's taxed now, what's taxed when escrow is paid, and what rolls into buyer stock.

General information, not tax advice. Acquisition treatment depends on how each deal is structured. Review your deal documents with a tax professional before closing.