Purchase Stock Using an IRA


It is very common for founders or early employees to have an opportunity to buy a substantial amount of stock in a promising startup company at a very low price. If your Individual Retirement Account (IRA) is sufficiently funded, you can create an IRA account at a special financial institution such as Pensco, rollover just enough money to this IRA, and then purchase your stock or exercise your stock options using that IRA money. By doing so, all gains on this investment will accrue tax-deferred until you withdraw the money at age 59 1/2 or higher. This is especially beneficial if you experience a hot IPO in a bubble market. Normally, if you sell your stock in order to preserve the large gains, then you'll be immediately subject to capital gains taxes. On the other hand, if your investment is held in an IRA, even selling the stock will not trigger taxes and you'll have captured profits without having to endure years of price volatility.

Roth IRA

Normally, highly compensated employees at fast growing technology companies are not eligible to make Roth IRA contributions. However, the IRS frequently allows IRA conversions as a mechanism to generate near term tax revenue for the government. During such a window, you can convert your IRA into a Roth IRA by paying the taxes on the amount converted as if it was an authorized distribution. Although the taxes paid effectively increases the amount that you have invested in your stock, your return on investment can be enormous since the final proceeds will be tax free for the most part as opposed to merely tax deferred in the case of regular IRAs. Note that the amount of taxes you pay on your Roth conversion will be a function of the fair market value of your stock at the time of conversion, so it is best that you do it early on while the valuation is still low. Although Qualified Small Business Stock(QSBS) exemptions can be less expensive to execute, the tax savings is limited to federal tax for many states, the investment must be held at least 5 years, and the exemption on capital gains is capped at the higher of $10 million or 10x the invested capital. Although an investment using a Roth IRA doesn't have those QSBS limitations, it is subject to many other restrictions. Be aware that the rules governing IRA's outline a number of prohibited transactions including self dealing in situations where you control the asset in which you invested. That can be risky for founders who own a large percentage of their companies. Since this is a grey area of the law, it is highly recommended that you seek professional advice before doing this.

If you hold employee stock options or restricted shares in a private company funded by institutional venture capital, feel free to contact us at the Employee Stock Option Fund for more information on how we can assist you. By doing so, you can not only avoid the risks associated with investing directly in a startup but possibly improve your taxes as well.

For specific tax related support related to stock option exercises, please contact Scott Chou.

This innovative service promotes and enables a healthier relationship between companies and employees. I my opinion it's valuable to employees and great for the overall tech environment and economy. It is good for nobody when employees feel trapped because they can't afford to leave. In less extreme cases exercising can be expensive and somewhat risky and this is simply a good smart hedge and a good square deal. Brilliant!

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