The original point of ISOs was to offer to employees the opportunity to take an economic risk with stock options (by exercising and paying for the stock at the bargain price) while avoiding the tax risk (by generally not recognizing ordinary income from that exercise and being taxed only at the time the stock was sold, and then only as a capital gains tax).
AMT has since emerged to devour the value of this benefit. By having to include the value of the spread (difference between exercise price and fair market value of the stock on date of exercise) as AMT income and pay tax on it at 28%-type rates, an employee can incur great tax risk in exercising options - especially for a venture that is in advanced rounds of funding but for which there is still no public market for trading of the shares. Even secondary markets for closely held stock are much restricted given the restrictions on transfer routinely written into the stock option documentation these days.
So why not just pass a law saying that the value of the spread is exempt from AMT? Of course, that would do exactly what is needed.
The problem is that AMT, which began in the late 60s as a "millionaire's tax", has since grown to be an integral part of how the federal government finances its affairs and is thus, in its perverse sort of way, a sacred cow untouchable without seriously disturbing the current political balance that is extant today.
And so this half-measure that helps a bit, not by eliminating the tax risk but only by deferring it and also for only some but not all potentially affected employees.
So, if you incur a several hundred thousand dollar tax hit because you choose to exercise your options under this measure, and then your venture goes bust for some reason, it appears you still will have to pay the tax down the road - thus, tax disasters are still possible with this measure. Of course, in optimum cases (and likely even in most cases), employees can benefit from this measure because they don't have to pay tax up front but only after enough time lapses by which they can realize the economic value of the stock.
This "tax breather" is a positive step and will make this helpful for a great many people. Not a complete answer but perhaps the best the politicians can do in today's political climate. It would be good if it passes.
You can keep deducting that capital loss on the options exercise going forward against future capital gains, and up to $3000 more can be deducted against regular income each year until you balance everything out.
BUT
Since the gain is actually unrealized the best answer is ask your CPA. Really.
Its usually a bad idea to take stock options instead of a market rate salary because most options are worthless in the long run. Lots of people do it anyway because they have a fantasy about making it big. As it stands now this is a life lesson that people spend some time in their 20s figuring out and probably walk away with nothing but some valuable experience.
Under the current scheme exercising illiquid options is a bad idea most of the time if you can't pay the taxes on it and this is obvious. This change doesn't make it a better idea but it makes it much less obvious that its a bad idea.
That 20 something that would have walked away with nothing will be much more likely to walk away with a 6 or 7 figure tax debt that may cripple him financially for the rest of his life.
> Only startups offering stock options to at least 80 percent of their workforce would be eligible for tax deferrals, and a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
I understand the desire to avoid a regressive taxation system, but why is it that every tax rule we create comes with 2x the amount of caveats and rules? Our tax system is becoming a mess.
At this rate soon nobody will be able to file their own taxes without an accountant to sort through the muck. And complicated to systems tend to benefit the wealthy.
> At this rate soon nobody will be able to file their own taxes without an accountant to sort through the muck. And complicated to systems tend to benefit the wealthy.
It also heavily benefits Quicken. Along with HR Block, they heavily lobby against any effort that simplifies the tax code. Capitalism, American-style.
the US is in a weird position where the federal government actually has very little power. But it has tax power. So they just use taxes as a way to manipulate things in the way they want.
But as far as I understand, the US tax system is also one of the 2-3 most complicated in the world... Being an permanent resident and not being used to this from my home country, Im making a lot of suboptimal financial decisions purely to avoid complicating my taxes... eg: I avoid consulting like plague, even when I have a worthwhile opportunity to do so.
> a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
Where is the line drawn on this? I am a companies highest paid executive... I make a whopping $100k. Some of the others have no pay check at all. Exersizing would net a $40k tax bill for me. 40% of my pre-tax take-home pay. But as the highest paid executive am I exempt from deferring?
Edit: to answer my own questions...
> who has been for any of the 10 preceding taxable years one of the 4 highest compensated officers of such corporation determined with respect to each such taxable year on the basis of the shareholder disclosure rules for compensation under the Securities Exchange Act of 1934
Translation... I guess this doesn't benefit me, then.
A complicated tax system is perfectly fine if its control logic is algorithmic and its parameters are easily found by the taxpayer. That's already somewhat true, since tax law is written by lawyers and accounts, who make excellent programmers if given appropriate training. Unfortunately, for me at least, legal English is 1000x harder to parse and understand than any nonesoteric programming language.
The tax system has always been a mess and there are exceptions and loopholes for everything. I don't disagree that it's bad, but I don't know why you'd expect it to change all of the sudden with these rules.
And those two specific exceptions don't seem particularly bad, IMO.
This is to stop people from gaming the system. For example: a company founder started offering stock options but only to their children. This would allow a parent to pass their company to their children avoiding estate taxes.
I agree that there's too much added complexity in the tax-code but do you really feel that this requirement is that onerous?
The likely motivation being being in line with those around 401k account requirements: if a company uses this, it should be to the benefits of the employees and not just the executive staff.
It's quite common to owe taxes today for gains on the value of your stock -- which is an illiquid asset you can't sell. This puts employees in the position of shelling out cash to keep something that rightfully belongs to them, or simply abandoning it (failing to exercise) when they leave the company. This bill would defer taxes on gains up to 7 years, or until the company goes public.
If you are awarded stock options, an you exercise them, you have to file an 83(b) election within 90 days or else you are liable on all paper gains in the value of your stock.
Even if you file an 83b election, you are still liable for paper gains between the value of your options when you were granted them and the value when you exercised.
For example, if you were awarded options with a strike price of $5 and the company raised a new round of funding and the 409A valuation (& strike price of the new options) has risen to $15 per share, the IRS considers that you now owe taxes on $10 of income / share. In other words, it costs you not $5 / share to exercise but ~$8.50 including taxes.
So the tricky part about options is that they require money to exercise, money that you often don't have ready, in order to obtain an asset that is (a) not liquid and (b) may decline in value (c) you often can't sell due to transfer restrictions.
For example: one early engineer at Zenefits had to pay $100,000 in taxes for exercising his stock....and then all the crap hit the fan, and he likely paid more in taxes than his shares will end up being worth. Ouch.
As a result of this problem with options, many startups -- especially later-stage ones like Uber -- choose instead to offer RSUs, which are basically stock grants as opposed to stock options. You don't have to pay any money to "get" them like you do for options.
However, the IRS considers stock grants, unlike options, immediately taxable income. If you get 10,000 RSUs per year, and the stock is valued at $5/share by an auditor, you now have to pay taxes on $50,000 of additional income, for an asset that you likely have no way of selling.
Some startups allow "net" grants -- which basically means they keep ~35% of your stock in lieu of taxes. That solves the liquidity problem, but offering this is completely at the discretion of the startup and some don't, which leaves employees at the mercy of the IRS, again having to pay cash on paper gains of an illiquid asset.
> For example: one early engineer at Zenefits had to pay $100,000 in taxes for exercising his stock....and then all the crap hit the fan, and he likely paid more in taxes than his shares will end up being worth. Ouch.
Would this bill actually help this scenario? I'm unclear if deferring the tax liability just means that you pay the same amount of tax later, or if you can write off capital losses like this at the time your liability is due.
"Even if you file an 83b election, you are still liable for paper gains between the value of your options when you were granted them and the value when you exercised."
Wouldn't this be taxed as capital gains though - when exercised?
A typical structure for RSUs (Uber included) is to delay activation until liquidity is possible. Until then, a contractual obligation to deliver the RSUs is what the employee actually possesses (after vest). Employees are free to exercise RSUs and pay the income tax hit, but I can't imagine a scenario when that would be rational. Especially since the company holds vested RSUs for separated employees.
Nobody at Uber is having to sell their Tesla P80 to cover the tax from their newly-vested RSUs after their annual cliff occurs.
True, but is it the IRS' fault if the corporation refuses to create a market for their shares? If the IRS didn't tax these shares, it would quickly become a tax shelter of epic proportions, no?
The liquidity of startup shares has gotten better in recent times. I'm an engineer at http://www.equityzen.com, a marketplace for pre-IPO shares, and I believe more shareholders are starting to see that selling before an exit is a viable option for faster liquidity.
We helped lobby and push for this bill and I'm glad to see it making progress in providing better options for startup employees.
Most employees get hit by the AMT and the step up in basis when exercising their incentive employee stock options, and from just skimming the bill, I don't see how that is prevented.
If the income is deferred, I would imagine that it wouldn't apply to AMT calculations. It'd be nice for that language to be explicit though.
Regardless, the Obama Administration "strongly opposes" the bill in its current form since it would "increase the Federal deficit by $1 billion over the next 10 years."
I was looking for that language as well - I expected to see that "gains" from exercising options do not count towards AMT, and that related taxes are completely deferred until the time when the investment becomes liquid (or 7 years?).
This sounds great, though requiring "offering 80% of the workforce stock" and excluding highest paid executives seems vague - is this at time of hiring, when stock is issued, fully vested, when taxes are due, somewhere inbetween? I parted ways with a startup in the valley last year and exercised some shares on January 13th. If I had exercised just two weeks earlier, I'm told I would've been hit with north of 50k in AMT, I have until next year to figure it out now but I wonder if I'm eligible. Also curious how long it typically takes to get from house, through the senate and passed.
From the bill, a corporation qualifies (aka the current state of affairs) if...
such corporation has a
written plan under which, in such
calendar year, not less than 80 percent
of all employees who provide services
to such corporation in the United
States (or any possession of the United
States) are granted stock options, or
restricted stock units, with the same
rights and privileges to receive
qualified stock.
I still don't understand why taxes are owed. If an option at the time of grant is worth $0 (which is how it's typically done or is that not the case?), then you don't owe anything to the IRS until you exercise the option, i.e. buy shares at the option price and sell them at presumably higher valuation and make some money, at which point you will need to part with some of it because it's income.
But if you never exercise the options, then you never owe any tax. What am I missing here?
If you exercise your ISO options (because of option expiration clauses, typically 90 days after you leave a company), but then don't (or can't due to no market for the shares) immediately sell those shares, the spread between the option grant price and the current 409A valuation is due as AMT tax. You have not realized an event where cash is in your pocket, but you still owe tax on the "gain".
You ask what does it matter if the options aren't exercised. Excellent question! It means all that potential compensation you were offered (because you took a lower salary usually in return for options) is now worthless. People don't want to work for free, or have their potential future compensation evaporate.
Frequently, companies have a 90-day exercise window on options, meaning that employees have to exercise within 90 days of termination of employment. What that often translates into is employees sticking around indefinitely at companies whose value has grown during their tenure because they:
- can't exercise options and leave, because they would have to pay potentially huge taxes on an illiquid asset
- don't want to lose their stock, which makes up a nontrivial part of their comp for effort already invested in the company
So, your understanding is correct - but people often don't want to wait for a liquidity event to be able to exercise and don't want to miss out on something they already earned.
An example: as I hear it, there are quite a few early Uber employees sitting on tens or hundreds of millions of options who can't leave because if they exercise, they'd be slammed with millions in taxes. Since Travis Kalanick disallows secondary market trading of Uber stock, they wouldn't be able to sell stock to help pay the taxes, and thus can't afford to exercise but can't afford to leave. That's how you end up with employees who just come in to work the minimum possible amount waiting for an exit.
More evidence as to why the income tax should be replaced with a consumption tax. Just let people make their dammed money already and apply a simple tax when they spend it. Windfalls wouldn't be "dangerous" or punitive in that model, and savers would be rewarded.
--Of course I oversimplify the consumption tax, and safeguard would need to be in place on that to ensure it is not regressive with respect to necessities...
Why all the goofy eligibility rules? Just get rid of the rule where exercising stock options counts as income under the AMT(1). It's line 14 in Part 1 of Form 6251. Just get rid of it!
When people talk about our tax system being too complicated bills like this are why.
1. For that matter we should get rid of the AMT entirely. The fact that we have 2 separate tax systems for individuals is insane. That's a bigger story though.
What the house needs to do is regulate startup's shady options agreements. I see way too many developers getting burned out striving for that big payout that may never come. It's the classic con game.
Companies have the right of first refusal and don't like lots of unrelated people on their cap table who only hold a small amount of shares, so don't expect this to work out
I would check out sharespost, equityzen, or equidate (and also search for them on Hacker News, as I found others mention experience with sharespost). I don't have direct experience, but I was helping a friend with a number of shares in a late stage startup research the sell side, and those are the companies that came up.
It crossed my mind to buy shares but I haven't done so. For some of them, you have to be an accredited investor, which means a certain net worth/income threshold to be met. (I think the SEC is trying to prevent naive investors from getting fleeced in this "dark" market). SharesPost seems to have a fund that gets you exposure to a lot of late stage startups.
AngelList apparently has a fund for early stage startups... if anyone knows anything about that I would appreciate any feedback.
EDIT with more info: From my research, buying from every company is different. That is why companies like SharesPost exist. And you really should have the permission of the company to do the transaction.
I think it may be possible to do it without their permission, but that's beyond my knowledge. There should be employees willing to go through this effort because they stand to benefit because you are offsetting their tax risk.
How does this relate to the push for startups to change from a 90 day to 10 year exercise window? It seems like that's a better option than this bill since it gives employees a larger time window to make an exercise decision, during which the likelyhood of options actual resulting in something liquid is much higher
Perhaps I'm misreading the law, but it looks like it solves the wrong problem: It addresses a cash-flow issue rather than the tax liability issue.
Say you have options at FooCorp and you leave. FooCorp is illquid and you have 90 days to exercise your 10,000 options. Your FC options have a $5 strike, but the company currently has a 409a valuation of $100/share.
To exercise the options you would need to pay $50,000 to FooCorp, then you would have a "realized gain" 950k (($100-$5)*10000 which you would owe 28% of in taxes that year, or 266k. So you would need access to $316k in total in order to exercise these options.
Two issues arise: (1) You may not have $316k just kicking around. (2) THE SHARES ARE ILLIQUID AND MAY BE WORTH $0 WHEN YOU CAN ACTUALLY DO ANYTHING WITH THEM.
The bill appears to help with (1) by letting you pay that 266k not now-- but later when the company shares become liquid or 7 years (whichever comes first). But it does nothing about (2) -- you might exercise and then the company goes bust, and seven years later you owe $266k and your current position is worth -50k... and because the taxes are AMT, you can't meaningfully write them off your losses against the taxes you owe.
This kind of failure doesn't require FooCorp to fail. You could have options at $5, execute at $100, and have things go liquid at $7-- ignoring taxes this would have been a $20k gain. But with the taxes you're still $246k in the hole.
The issue all along wasn't that someone needed extra money. The issue was the potential huge losses. If it weren't risky you could find a lender to cover the execution price and taxes in exchange for a return when the asset becomes liquid. (E.g. having to pay the $266k up front but getting it returned later when the asset becomes worthless and you write it off)
If anything this makes the situation worse by encouraging more people to commit financial suicide by making it less obviously a bad idea while being just as risky as it always was.
> Only startups offering stock options to at least 80 percent of their workforce would be eligible for tax deferrals, and a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
>In the United States, this approach impacts personal tax liability, because although stock and option grants are taxed at federal income rates, they may be exempt from some portion of payroll taxes (typically 7.65%) used to fund Social Security and Medicare.
They're still considered highly-compensated, just not through payroll.
$1 salaries is because they get paid through a complicated structure that eventually means they owe capital gains tax (20%) instead of income tax (40%).
How would this affect the concept of phantom stock options? I worked at a startup who used the main excuse of no taxes paid handing out ghost options instead of normal options.
"Phantom stock can, but usually does not, pay dividends. When the grant is initially made or the phantom shares vest, there is no tax impact. When the payout is made, however, it is taxed as ordinary income to the grantee and is deductible to the employer."
Just because the house passes a bill doesn't mean it's a law. It also has to pass the Senate and be signed by the President (or go through the veto process).
The article appears to get the "seven years" qualification wrong. The bill states that tax must be paid at:
>> the date that is 7 years after the first date the rights of the employee in such stock are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier
Which implies that transfer-restricted stock grants do not start this clock ticking.
[+] [-] grellas|9 years ago|reply
AMT has since emerged to devour the value of this benefit. By having to include the value of the spread (difference between exercise price and fair market value of the stock on date of exercise) as AMT income and pay tax on it at 28%-type rates, an employee can incur great tax risk in exercising options - especially for a venture that is in advanced rounds of funding but for which there is still no public market for trading of the shares. Even secondary markets for closely held stock are much restricted given the restrictions on transfer routinely written into the stock option documentation these days.
So why not just pass a law saying that the value of the spread is exempt from AMT? Of course, that would do exactly what is needed.
The problem is that AMT, which began in the late 60s as a "millionaire's tax", has since grown to be an integral part of how the federal government finances its affairs and is thus, in its perverse sort of way, a sacred cow untouchable without seriously disturbing the current political balance that is extant today.
And so this half-measure that helps a bit, not by eliminating the tax risk but only by deferring it and also for only some but not all potentially affected employees.
So, if you incur a several hundred thousand dollar tax hit because you choose to exercise your options under this measure, and then your venture goes bust for some reason, it appears you still will have to pay the tax down the road - thus, tax disasters are still possible with this measure. Of course, in optimum cases (and likely even in most cases), employees can benefit from this measure because they don't have to pay tax up front but only after enough time lapses by which they can realize the economic value of the stock.
This "tax breather" is a positive step and will make this helpful for a great many people. Not a complete answer but perhaps the best the politicians can do in today's political climate. It would be good if it passes.
Edit: text of the bill is here: https://www.congress.gov/bill/114th-congress/house-bill/5719... (Note: it is a deferral only - if the value evaporates, you still owe the tax).
[+] [-] jnordwick|9 years ago|reply
BUT
Since the gain is actually unrealized the best answer is ask your CPA. Really.
[+] [-] yaur|9 years ago|reply
I'm really not sure that's true.
Its usually a bad idea to take stock options instead of a market rate salary because most options are worthless in the long run. Lots of people do it anyway because they have a fantasy about making it big. As it stands now this is a life lesson that people spend some time in their 20s figuring out and probably walk away with nothing but some valuable experience.
Under the current scheme exercising illiquid options is a bad idea most of the time if you can't pay the taxes on it and this is obvious. This change doesn't make it a better idea but it makes it much less obvious that its a bad idea.
That 20 something that would have walked away with nothing will be much more likely to walk away with a 6 or 7 figure tax debt that may cripple him financially for the rest of his life.
[+] [-] matt_wulfeck|9 years ago|reply
I understand the desire to avoid a regressive taxation system, but why is it that every tax rule we create comes with 2x the amount of caveats and rules? Our tax system is becoming a mess.
At this rate soon nobody will be able to file their own taxes without an accountant to sort through the muck. And complicated to systems tend to benefit the wealthy.
[+] [-] __jal|9 years ago|reply
It also heavily benefits Quicken. Along with HR Block, they heavily lobby against any effort that simplifies the tax code. Capitalism, American-style.
[+] [-] shados|9 years ago|reply
But as far as I understand, the US tax system is also one of the 2-3 most complicated in the world... Being an permanent resident and not being used to this from my home country, Im making a lot of suboptimal financial decisions purely to avoid complicating my taxes... eg: I avoid consulting like plague, even when I have a worthwhile opportunity to do so.
[+] [-] throwaway2016a|9 years ago|reply
Where is the line drawn on this? I am a companies highest paid executive... I make a whopping $100k. Some of the others have no pay check at all. Exersizing would net a $40k tax bill for me. 40% of my pre-tax take-home pay. But as the highest paid executive am I exempt from deferring?
Edit: to answer my own questions...
> who has been for any of the 10 preceding taxable years one of the 4 highest compensated officers of such corporation determined with respect to each such taxable year on the basis of the shareholder disclosure rules for compensation under the Securities Exchange Act of 1934
Translation... I guess this doesn't benefit me, then.
[+] [-] hx87|9 years ago|reply
[+] [-] jlarocco|9 years ago|reply
And those two specific exceptions don't seem particularly bad, IMO.
[+] [-] pm24601|9 years ago|reply
[+] [-] iaw|9 years ago|reply
The likely motivation being being in line with those around 401k account requirements: if a company uses this, it should be to the benefits of the employees and not just the executive staff.
[+] [-] Cyclone_|9 years ago|reply
[+] [-] djrogers|9 years ago|reply
"the Administration strongly opposes H.R. 5719 because it would increase the Federal deficit by $1 billion over the next ten years." [1]
So a really bad tax rule is in place, but since it happens to bring in ~$100M/yr, we shouldn't fix the rule?
[1]https://www.whitehouse.gov/sites/default/files/omb/legislati...
[+] [-] dragonwriter|9 years ago|reply
Assuming, for the sake of argument, agreement that the rule is bad, fixing it without paying the cost at the same time may still be worse.
[+] [-] calcsam|9 years ago|reply
It's quite common to owe taxes today for gains on the value of your stock -- which is an illiquid asset you can't sell. This puts employees in the position of shelling out cash to keep something that rightfully belongs to them, or simply abandoning it (failing to exercise) when they leave the company. This bill would defer taxes on gains up to 7 years, or until the company goes public.
If you are awarded stock options, an you exercise them, you have to file an 83(b) election within 90 days or else you are liable on all paper gains in the value of your stock.
Even if you file an 83b election, you are still liable for paper gains between the value of your options when you were granted them and the value when you exercised.
For example, if you were awarded options with a strike price of $5 and the company raised a new round of funding and the 409A valuation (& strike price of the new options) has risen to $15 per share, the IRS considers that you now owe taxes on $10 of income / share. In other words, it costs you not $5 / share to exercise but ~$8.50 including taxes.
So the tricky part about options is that they require money to exercise, money that you often don't have ready, in order to obtain an asset that is (a) not liquid and (b) may decline in value (c) you often can't sell due to transfer restrictions.
For example: one early engineer at Zenefits had to pay $100,000 in taxes for exercising his stock....and then all the crap hit the fan, and he likely paid more in taxes than his shares will end up being worth. Ouch.
As a result of this problem with options, many startups -- especially later-stage ones like Uber -- choose instead to offer RSUs, which are basically stock grants as opposed to stock options. You don't have to pay any money to "get" them like you do for options.
However, the IRS considers stock grants, unlike options, immediately taxable income. If you get 10,000 RSUs per year, and the stock is valued at $5/share by an auditor, you now have to pay taxes on $50,000 of additional income, for an asset that you likely have no way of selling.
Some startups allow "net" grants -- which basically means they keep ~35% of your stock in lieu of taxes. That solves the liquidity problem, but offering this is completely at the discretion of the startup and some don't, which leaves employees at the mercy of the IRS, again having to pay cash on paper gains of an illiquid asset.
[+] [-] Eridrus|9 years ago|reply
Would this bill actually help this scenario? I'm unclear if deferring the tax liability just means that you pay the same amount of tax later, or if you can write off capital losses like this at the time your liability is due.
[+] [-] nitinics|9 years ago|reply
Wouldn't this be taxed as capital gains though - when exercised?
[+] [-] linkregister|9 years ago|reply
Nobody at Uber is having to sell their Tesla P80 to cover the tax from their newly-vested RSUs after their annual cliff occurs.
[+] [-] harryh|9 years ago|reply
[+] [-] asah|9 years ago|reply
That's the core issue: the IRS is taxing individuals on truly illiquid assets.
[+] [-] jimbokun|9 years ago|reply
[+] [-] bofia|9 years ago|reply
We helped lobby and push for this bill and I'm glad to see it making progress in providing better options for startup employees.
[+] [-] jnordwick|9 years ago|reply
[+] [-] stustein|9 years ago|reply
Regardless, the Obama Administration "strongly opposes" the bill in its current form since it would "increase the Federal deficit by $1 billion over the next 10 years."
https://www.whitehouse.gov/sites/default/files/omb/legislati...
I wonder how often bills with this "strong opposition" still end up getting passed anyway.
[+] [-] breerly|9 years ago|reply
[+] [-] martin_|9 years ago|reply
[+] [-] tetrep|9 years ago|reply
such corporation has a written plan under which, in such calendar year, not less than 80 percent of all employees who provide services to such corporation in the United States (or any possession of the United States) are granted stock options, or restricted stock units, with the same rights and privileges to receive qualified stock.
[+] [-] breerly|9 years ago|reply
My guess is that this applies in most common cases, although I wonder what the situation they were trying to guard from was...
[+] [-] gtrubetskoy|9 years ago|reply
But if you never exercise the options, then you never owe any tax. What am I missing here?
[+] [-] toomuchtodo|9 years ago|reply
You ask what does it matter if the options aren't exercised. Excellent question! It means all that potential compensation you were offered (because you took a lower salary usually in return for options) is now worthless. People don't want to work for free, or have their potential future compensation evaporate.
[+] [-] kornish|9 years ago|reply
- can't exercise options and leave, because they would have to pay potentially huge taxes on an illiquid asset
- don't want to lose their stock, which makes up a nontrivial part of their comp for effort already invested in the company
So, your understanding is correct - but people often don't want to wait for a liquidity event to be able to exercise and don't want to miss out on something they already earned.
An example: as I hear it, there are quite a few early Uber employees sitting on tens or hundreds of millions of options who can't leave because if they exercise, they'd be slammed with millions in taxes. Since Travis Kalanick disallows secondary market trading of Uber stock, they wouldn't be able to sell stock to help pay the taxes, and thus can't afford to exercise but can't afford to leave. That's how you end up with employees who just come in to work the minimum possible amount waiting for an exit.
[+] [-] revo13|9 years ago|reply
--Of course I oversimplify the consumption tax, and safeguard would need to be in place on that to ensure it is not regressive with respect to necessities...
[+] [-] zkhalique|9 years ago|reply
https://en.wikipedia.org/wiki/Companies_of_the_United_States...
[+] [-] adanto6840|9 years ago|reply
[+] [-] harryh|9 years ago|reply
When people talk about our tax system being too complicated bills like this are why.
1. For that matter we should get rid of the AMT entirely. The fact that we have 2 separate tax systems for individuals is insane. That's a bigger story though.
[+] [-] ap22213|9 years ago|reply
[+] [-] mrfusion|9 years ago|reply
[+] [-] Eridrus|9 years ago|reply
[+] [-] chubot|9 years ago|reply
It crossed my mind to buy shares but I haven't done so. For some of them, you have to be an accredited investor, which means a certain net worth/income threshold to be met. (I think the SEC is trying to prevent naive investors from getting fleeced in this "dark" market). SharesPost seems to have a fund that gets you exposure to a lot of late stage startups.
AngelList apparently has a fund for early stage startups... if anyone knows anything about that I would appreciate any feedback.
EDIT with more info: From my research, buying from every company is different. That is why companies like SharesPost exist. And you really should have the permission of the company to do the transaction.
I think it may be possible to do it without their permission, but that's beyond my knowledge. There should be employees willing to go through this effort because they stand to benefit because you are offsetting their tax risk.
[+] [-] jkern|9 years ago|reply
[+] [-] nullc|9 years ago|reply
Say you have options at FooCorp and you leave. FooCorp is illquid and you have 90 days to exercise your 10,000 options. Your FC options have a $5 strike, but the company currently has a 409a valuation of $100/share.
To exercise the options you would need to pay $50,000 to FooCorp, then you would have a "realized gain" 950k (($100-$5)*10000 which you would owe 28% of in taxes that year, or 266k. So you would need access to $316k in total in order to exercise these options.
Two issues arise: (1) You may not have $316k just kicking around. (2) THE SHARES ARE ILLIQUID AND MAY BE WORTH $0 WHEN YOU CAN ACTUALLY DO ANYTHING WITH THEM.
The bill appears to help with (1) by letting you pay that 266k not now-- but later when the company shares become liquid or 7 years (whichever comes first). But it does nothing about (2) -- you might exercise and then the company goes bust, and seven years later you owe $266k and your current position is worth -50k... and because the taxes are AMT, you can't meaningfully write them off your losses against the taxes you owe.
This kind of failure doesn't require FooCorp to fail. You could have options at $5, execute at $100, and have things go liquid at $7-- ignoring taxes this would have been a $20k gain. But with the taxes you're still $246k in the hole.
The issue all along wasn't that someone needed extra money. The issue was the potential huge losses. If it weren't risky you could find a lender to cover the execution price and taxes in exchange for a return when the asset becomes liquid. (E.g. having to pay the $266k up front but getting it returned later when the asset becomes worthless and you write it off)
If anything this makes the situation worse by encouraging more people to commit financial suicide by making it less obviously a bad idea while being just as risky as it always was.
[+] [-] koolba|9 years ago|reply
Is this why I keep seeing nominal $1 salaries?
[+] [-] steve-howard|9 years ago|reply
>In the United States, this approach impacts personal tax liability, because although stock and option grants are taxed at federal income rates, they may be exempt from some portion of payroll taxes (typically 7.65%) used to fund Social Security and Medicare.
They're still considered highly-compensated, just not through payroll.
[+] [-] whamlastxmas|9 years ago|reply
[+] [-] aetherson|9 years ago|reply
[+] [-] AdamN|9 years ago|reply
[+] [-] cdbattags|9 years ago|reply
"Phantom stock can, but usually does not, pay dividends. When the grant is initially made or the phantom shares vest, there is no tax impact. When the payout is made, however, it is taxed as ordinary income to the grantee and is deductible to the employer."
https://en.wikipedia.org/wiki/Phantom_stock
[+] [-] k2xl|9 years ago|reply
Does this mean I don't owe AMT addition next year?
[+] [-] harryh|9 years ago|reply
Just because the house passes a bill doesn't mean it's a law. It also has to pass the Senate and be signed by the President (or go through the veto process).
[+] [-] stevenae|9 years ago|reply
>> the date that is 7 years after the first date the rights of the employee in such stock are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier
Which implies that transfer-restricted stock grants do not start this clock ticking.