Senate plans disastrous tax on vesting that could kill stock compensation

[Traderjohnsblog]

You are entirely missing the point. It matters a whole hell of a lot if I have to pay taxes on options the day they vest when I'm making $50,000 a year living in San Francisco and there's a non-zero probability that I'll never even exercise the options because the company won't be in business in 5 years, vice paying those taxes when the company IPOs and the I exercise the options into stock I can easily sell for far more than I owe in taxes. Startups don't think about taxes at all except the taxes they have to pay when they're in startup phase and every dollar counts as the difference between success and failure. This bill moves taxes from the realm of "wish I didn't have to pay so much of my windfall in taxes" to "can't do this job because I can't afford taxes on money I haven't made yet". Huge Huge difference in how people make decisions and outcomes for entire industries.

As for waiting for options to vest until they're sellable. First, read section 409A of the tax code. Generally deferred compensation is not only taxable but has an extra 20% tax penalty attached, and what you're proposing would clearly fall under 409A.
Second, I'm not sure you get the point of vesting. It's the primary mechanism in the startup world to reward longevity of effort from employees. You give an employee a decent set of options, and put them on a 3 year vesting schedule so the longer they stay the more of the options they get. Any options that vest are theirs to keep, even if they leave before 3 years. Your idea eliminates both the central tenants of vesting, so again why blow up what's worked so well for....wait a minute why are we doing this again? Because jobs?

I had go read section 409A. Sect. 409A would apply to deferred income even under todays existing rules. The 20 percent tax penalty applies when the options are granted at discount or the company valuation was considerably off from fair market value. Assuming the new law does not change rule 409A the point becomes moot. It will be the same tomorow as it is today.

With regard to deffered income. Today one could get paid in stock options and except for a few rare circumstances they are not taxed on that income until they excercise the option. Under the new rules they could be paid with stock options and they are not taxed until the options vest. Since we as owners and principles determine when the vest we simply allow them vest only after the company goes public. That takes care of the unregistered sale of securities mentioned by Sig.

One could argue that forcing one to pay taxes on deffered income earlier rather than later might be beneficial if the tax payer is in a lower tax bracket then they will be 10 years down the road. That would of course be specific to each individuals tax profile.

In short they are taxing the same income at the same rate. The IRS is just getting thier money sooner. I think this change will be very easy to write around legally and should have minimal impact.

 

[Sig]

I had go read section 409A. Sect. 409A would apply to deferred income even under todays existing rules. The 20 percent tax penalty applies when the options are granted at discount or the company valuation was considerably off from fair market value. Assuming the new law does not change rule 409A the point becomes moot. It will be the same tomorow as it is today.

With regard to deffered income. Today one could get paid in stock options and except for a few rare circumstances they are not taxed on that income until they excercise the option. Under the new rules they could be paid with stock options and they are not taxed until the options vest. Since we as owners and principles determine when the vest we simply allow them vest only after the company goes public. That takes care of the unregistered sale of securities mentioned by Sig.

One could argue that forcing one to pay taxes on deffered income earlier rather than later might be beneficial if the tax payer is in a lower tax bracket then they will be 10 years down the road. That would of course be specific to each individuals tax profile.

In short they are taxing the same income at the same rate. The IRS is just getting thier money sooner. I think this change will be very easy to write around legally and should have minimal impact.

Dude, at this point I feel like you're willfully misunderstanding or you are an academic who's completely out of touch with reality (this coming from someone with an MBA who highly respects most academics). You've clearly never worked at or with a startup, but still, try to put yourself in the shoes of a potential startup employee and a startup founder. Regardless of if 409 applied (it would if you tried to do what you're trying to do, that's the entire point of 409 if you know how it came about), as CEO of a startup I use vesting schedules to guarantee my employees stock options, given that they stay for a certain amount of time. i.e. I give you options to purchase 900 shares and 300 of those vest each year. So if you stay for 2 years, you leave with options to purchase 600 shares, if you stay all 3 you get all 900. It ensures you as an employee that you'll get a certain reward based on staying. It gives me as an employer a carrot to get you to stay. If I vest when the company IPO's, then that whole concept goes away. It would either require that everyone stay with the company until IPO, which makes the options useless since that's such an unknown and potentially lengthy commitment (not to mention most private company's don't exit via IPO). Or I would have to give everyone their full amount the day they started, which again kills the entire point of vesting. And vesting of non-qualified options is one of the biggest tools I as a startup CEO have to attract top talent when I can't afford to pay market rates for their services.

This isn't "easy to write around" and it won't have "minimal impact". This coming from someone who's actually played this game rather than someone who is so out of touch they appear to seriously think someone who took below market salary to work at a startup would rather pay their taxes at option vesting since they're in a lower tax bracket! As I and others clearly pointed out, you pay the taxes now on a very uncertain future payout, plus you're dead poor because you took options instead of salary, plus you care a lot about paying taxes in this scenario and really don't care much at all when your company just had a good exit. In no part of the real world of people really doing this does this not have a huge impact.

And once again, why the f*&k are we doing this again?

 

[newwurldmn]

And once again, why the f*&k are we doing this again?

As I pointed out earlier. They are screwing your employees by making them pay earlier, but eliminating the equivalent tax upon death. So the obvious solution is that your employees should kill themselves the year that their options vest.

 

[Sig]

As I pointed out earlier. They are screwing your employees by making them pay earlier, but eliminating the equivalent tax upon death. So the obvious solution is that your employees should kill themselves the year that their options vest.

Combined with TradeJohn's idea you get a bunch of employees who really really really don't want an IPO!

 

[ET180]

Getting back to the issue, it doesn't really make sense to tax stock at vesting (when an employee is able to sell it), but not options. Otherwise, what prevents a company from simply granting deep in the money call options with a very long expiration in order to allow their employees to defer compensation indefinitely into the future?

 

[Traderjohnsblog]

Dude, at this point I feel like you're willfully misunderstanding or you are an academic who's completely out of touch with reality (this coming from someone with an MBA who highly respects most academics). You've clearly never worked at or with a startup, but still, try to put yourself in the shoes of a potential startup employee and a startup founder. Regardless of if 409 applied (it would if you tried to do what you're trying to do, that's the entire point of 409 if you know how it came about), as CEO of a startup I use vesting schedules to guarantee my employees stock options, given that they stay for a certain amount of time. i.e. I give you options to purchase 900 shares and 300 of those vest each year. So if you stay for 2 years, you leave with options to purchase 600 shares, if you stay all 3 you get all 900. It ensures you as an employee that you'll get a certain reward based on staying. It gives me as an employer a carrot to get you to stay. If I vest when the company IPO's, then that whole concept goes away. It would either require that everyone stay with the company until IPO, which makes the options useless since that's such an unknown and potentially lengthy commitment (not to mention most private company's don't exit via IPO). Or I would have to give everyone their full amount the day they started, which again kills the entire point of vesting. And vesting of non-qualified options is one of the biggest tools I as a startup CEO have to attract top talent when I can't afford to pay market rates for their services.

This isn't "easy to write around" and it won't have "minimal impact". This coming from someone who's actually played this game rather than someone who is so out of touch they appear to seriously think someone who took below market salary to work at a startup would rather pay their taxes at option vesting since they're in a lower tax bracket! As I and others clearly pointed out, you pay the taxes now on a very uncertain future payout, plus you're dead poor because you took options instead of salary, plus you care a lot about paying taxes in this scenario and really don't care much at all when your company just had a good exit. In no part of the real world of people really doing this does this not have a huge impact.

And once again, why the f*&k are we doing this again?

I feel your pain but this may be helpful for others, who knows. You grant the options when and how you like. They vest as you and your employees agree upon. Pre IPO or post IPO or both. Assuming there is a market for pre IPO shares they pay there taxes then. As long as the employee has some method for exercising thier options and converting them to cash they pay there taxes. If there is no market (likely the case) they hold them until IPO. Then pay the taxes. You determine when they vest. Write it accordingly.

 

[Sig]

I feel your pain but this may be helpful for others, who knows. You grant the options when and how you like. They vest as you and your employees agree upon. Pre IPO or post IPO or both. Assuming there is a market for pre IPO shares they pay there taxes then. As long as the employee has some method for exercising thier options and converting them to cash they pay there taxes. If there is no market (likely the case) they hold them until IPO. Then pay the taxes. You determine when they vest. Write it accordingly.

You're hopeless!