Maximize Employer Paid Social Security

Exercising NSOs (from a former company) when you're self-employed can reduce the Social Security taxes you have to pay by as much as 50%

Strategy Overview

Social Security tax is a bit unique in that (1) both (i) employees, and (ii) employers are responsible for paying their portion, and (2) that the tax is only applicable up to a maximum amount per year. If you have (or are planning to) leave an employer where you have vested NSOs to become self-employed, waiting to exercise your NSOs until a tax year when you are 100% self-employed can save you up to half of the Social Security tax burden you'd need to pay.

Tax Details

When you exercise NSOs, the bargain element is taxed as ordinary income, and is subject to Social Security (and Medicare taxes) under FICA. For Social Security, a 6.2% tax is paid by the employee, and another 6.2% is paid by the employer (up to that years annual max wage amount; $160,200 in 2023). Uniquely, even if you are no longer employed by the company, exercised NSOs are still considered ordinary income sourced to the employer.

If your NSOs allow you to exercise for a period of time (perhaps multiple years) into the future via a Post Termination Exercise Period (PTEP), and you are now self-employed, you have an opportunity to save on up to 50% of your Social Security taxes. Here's how/why:

• Social Security taxes are paid by both employee and employer up to a maximum per year. For example, if you have $160,000 of income:

  • $9,900 (6.2% of wages) Social Security tax paid by employee

  • $9,900 (6.2% of wages) Social Security tax paid by employer

  • $19,800 total Social Security taxes paid (the annual max) for your taxpayer ID

• When you are self-employed, you are both the employee and employer, and must pay the full 12.4% Social Security tax, up to the annual max (e.g. $19,800)

• Opportunity: If you waited to exercise NSOs (at/above SS annual max) until a year when you were self-employed (and generating income at/above the SS annual max):

  • $9,900 Social Security tax would be paid by you, the individual (i.e. normal).

  • $9,900 would be paid by your former employer due to exercising the NSO option, which created income associated with that employer (and thus your former employer was required to pay their employer 6.2% portion).

  • Result: The full annual Social Security maximum ($19,800) for your taxpayer ID is paid for the year, but your former employer has to pay the employer portion, allowing you to be responsible for only the employee portion (e.g. $9,900 vs $19,800).

Key Benefits

• Employer pays 6.2% of Social Security on NSO income up to annual max. Your overall Social Security tax burden can be reduced by up to 50% in some scenarios when you're self-employed.

Key Considerations/Flags

• Investment risk. Waiting to exercise vested NSOs, potentially for multiple years, requires you to take single-company investment risk. If you don't believe in the company's business prospects or are unwilling to accept this risk, then this strategy likely isn't right for you.

• Delayed cash from sale. Waiting to exercise vested NSOs, potentially for multiple years, delays the associated cash inflow from the exercise and sale of the holding.

• Both (1) the NSO bargain element and (2) your self employment income needs to be above the SS annual max to get the full benefits. Benefits of this strategy still exist with NSO income below the max and/or self-employment income below the max, but its a lower percentage.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• You plan to leave the company soon and be self-employed

• You have vested NSOs that (ideally) have an exercise extension multiple years into the future

• You believe in the company and are willing and able to take on the single-company investment risk of holding the NSO for a period of time into the future

• For the maximum benefit, both the income you'd generate from exercising your NSOs and the amount of self-employment income you'll have exceed the annual Social Security wage maximum

🔴 When to Not Use This Strategy:

• If you're leaving one employer to go work for another employer, this strategy will not apply

• If your NSOs have low or no bargain element

• If you're unable or unwilling to accept the single-company investment risk of holding the NSO for a period of time into the future

• If you anticipate needing cash (from the value of your unvested NSOs) near term

Example