Tax Basis: Calculating Your Cost

Tax basis represents the original cost of an asset, used to calculate capital gains or losses when you sell. Think of it as your financial starting point for tax purposes – it’s what you “paid” for your equity, even if you didn’t shell out cash directly. Understanding your tax basis is crucial for minimizing your tax liability when you sell private shares.

Why is Tax Basis Important in Private Markets?

In the world of private company equity, determining your tax basis can be trickier than with publicly traded stocks. This is because the initial “purchase” might involve various forms of compensation, each with its own tax implications:

• Stock Options (ISOs and NSOs): Your basis for stock acquired by exercising options is typically the exercise price plus any ordinary income recognized upon exercise (for NSOs). Learn More: Understanding Your Stock Options ISO vs NSO
• Restricted Stock Units (RSUs): Your basis is generally the fair market value of the shares on the date they vest. Learn More: RSUs Restricted Stock Units How They Work
• Employee Stock Purchase Plans (ESPPs): Your basis is typically the discounted price you paid for the shares. Learn More: Employee Stock Purchase Plans ESPPs Another Way to Acquire Stock

How is Tax Basis Used to Calculate Gain/Loss?

When you sell your shares, the difference between the sale price and your tax basis determines your capital gain or loss.

• Capital Gain: Sale price > Tax basis
• Capital Loss: Sale price < Tax basis

For example, if your basis for 100 shares is $10/share and you sell them for $20/share, your capital gain is $1,000 ([$20-$10] x 100). This gain will be taxed at either short-term or long-term capital gains rates depending on how long you held the shares. Learn More: Capital Gains Tax

What are some Common Pitfalls to Avoid?

• Keeping Accurate Records: Meticulous record-keeping is paramount. Track all grant dates, exercise prices, vesting dates, and sale prices for your equity. It’s common to overlook this, but it’s crucial for accurately calculating your basis down the road.
• Understanding AMT (Alternative Minimum Tax): Exercising ISOs can trigger AMT in the year of exercise. This is a separate tax calculation that can affect your overall tax liability. Learn More: Alternative Minimum Tax AMT
• Seeking Professional Advice: Tax laws around equity compensation can be complex. Consult with a qualified tax advisor for personalized guidance.

So here’s what we covered:

• Definition and importance of tax basis.
• How basis is determined for different equity types.
• How basis is used to calculate gains and losses.
• Common pitfalls to avoid, such as poor record-keeping and AMT implications.
• The importance of seeking professional tax advice.