Don’t Tax Options and RSUs Upon Vesting

http://avc.com/2017/11/dont-tax-options-and-rsus-upon-vesting/

by mooreds • 9 years ago

553 366 9 years ago

cletus• 9 years ago

So we need to split this issue between companies that are public (or otherwise have liquid equity) and those that don't.

For the big companies it's pretty easy. They're largely RSU based. Shares are vested/released. Many companies allow full autosale. Easy. Even in the case of selling enough shares to cover withholding your still left with something very liquid.

Options in public companies are in basically the same boat.

The tricky one is early stages startups.

If you have options that have an exercise price at or over market value then you can take a Rule 83(b) election to defer your entire tax liability til exercise.

If the exercise price is below market then that would mean paying tax on the entire grant even though you may never receive it. Easier option for founders than employees.

Either way it doesn't cover grants along the way.

I do think it's a reasonable complaint to get taxed on something you can't liquidate.

So two things jump out at me:

1. Issuing RSUs in a non-public company send like a bad idea. Does anyone actually do this?

2. The vast majority of tax revenue would come from FAMGA shares which are already taxed so what's actually going to be gained by this? Or is executive compensation (ie ISOs) able to get favorable treatment already? This reason sooner makes it seem like a bad idea.

EDIT: an answer to my own question (emphasis added):

https://www.recode.net/2017/11/12/16640530/uber-peace-deal-r...

Under terms of the deal agreed on, those eligible employees with stock options are capped at selling half their holdings (and those with restricted stock units cannot sell in this round).

So apparently some Uber employees have RSUs and Uber obiously public or liquid.

tome3• 9 years ago

I do think it's a reasonable complaint to get taxed on something you can't liquidate.

One way to sidestep this would be to force the taxing authority to take some of the options as payment, rather than cash. You've been granted 100 options at a value of $x each and the tax rate is 20%? Just give them 20 options. That way it doesn't matter what x is or whether the market is liquid!

stu2010• 9 years ago

This is the perfect solution if they really want to tax illiquid assets.

solipsism• 9 years ago

But who would manage this federal portfolio?

conanbatt11• 9 years ago

Smart!

cmrdporcupine• 9 years ago

This suggestion might actually force some of the startups that play dubious games with stock values (not disclosing total # of shares issued and current values) and preferred shares and the like to be more above board. In a way getting taxed on these things would at least make it clear what their 'value' is.

lg• 9 years ago

isn't this already a problem for RSU's, where you get taxed at vest time (or on the value at vest time)? Are there startups out there granting illiquid RSU's? seems like a bad fit.

sokoloff• 9 years ago

RSUs are taxed when vested and released. Vested but not released RSUs are not [yet] taxed.

Most companies issuing RSUs are doing so because there is a public market for them and so the release and vest date is the same.

cjlars• 9 years ago

1. Issuing RSUs in a non-public company send like a bad idea. Does anyone actually do this?

We offer stock grants (basically RSUs without a formal vesting schedule) to key employees at my firm and have had no issues. You say that there are issues with the vested stock not being liquid, but the issuing employer can simply offer to buy the shares back if needed at fair value if liquidity is needed, which we determine according to a formula which inputs the firm's balance sheet and trailing profitability.

This has the advantage of being very straight forward, both to the owners as the issuing party, and the employees -- but has the cost of being disadvantaged by the tax code.

Contemporary startup options packages are anything but that. Most of the time neither the employee receiving them nor the HR person explaining them has any idea how they really work -- but for all that opacity, they get a preferential tax treatment.

It's probably worth pointing out that the only reason startups rely so heavily on option compensation as opposed to simple equity grants are for the reasons above: they are tax advantaged, and the employees have no idea what they're getting. I wouldn't mind seeing the startup world return to a more easy to understand scheme.

ajmurmann2• 9 years ago

Can someone explain how the taxable amount would be calculated if the company isn't listed on the stock market. My options are for value x per share. I would expect to pay taxes for y - x with y being the market value. How does the actual market value get established? Will that number just come from what was used when someone invested previously?

buckhx2• 9 years ago

Fair Market Value determined by a 409a valuation.

bgentry2• 9 years ago

Interesting side note. This proposed legislation actually completely removes section 409A from the tax code and replaces some parts of it. I’m not sure if the rules around company valuation will change dramatically but it seems that they won’t be called 409A valuations anymore if this passes:

http://bakerxchange.com/rv/ff0034eed7a7d447f644f491d94caddcb...

aresant• 9 years ago

"But, sadly, I don’t think this is really about what makes sense. It is about politics."

Clearly this proposal is targeted directly at private SV and tech companies.

And the mortgage deduction and state tax write off proposals are targeted at California / NY.

Outside of just a big FU from the Republicans to largely Democratic states what is the end game?

E.g. - what are the Republicans actually negotiating for, assuming points like the RSUs are proposed as leverage vs real reform?

ajmurmann2• 9 years ago

I can't overstate how sad it would be if the goal of this change was plainly to stick to to Democrat states. It there is truly do much disdain that didn't boat well for the future as a united country.

JumpCrisscross3• 9 years ago

the goal of this change was plainly to stick to to Democrat states

That's not the goal but a predictable side effect of a single party emerging with dominance from close to a decade of structural gridlock. Republicans want to give their base, both donor and electoral, a tax cut. The national debt scares many of their constituents. As a result, they have to at least look like they're trying to avoid blowing the deficit. So they send the bill to outside their base.

This wasn't "let's screw our political opponents." It was "let's help our base and stick the bill to our opponents." Subtle, but different.

saas_co_de2• 9 years ago

The entire tax bill seems to be sticking it to Democrat states, in particular New York and California, but it is really about urban vs. rural politics.

Democrats have become too concentrated as a party in urban areas and so rural voters have gotten enough political power to attempt to address what they view as economic inequities in the current urban/rural income distribution.

Republican have also flipped the script on Democrats and so now they are proposing to tax the "rich" (actually urban middle class) and redistribute that to the poorer rural middle class.

It is funny because conservatives have been warning for decades that redistributionist games don't end well, while the Democrats have been advocating them, but now that the shoe is on the other foot it doesn't seem like such a good idea.

briandear4• 9 years ago

State tax write offs are fundamentally unfair. The US government effectively subsidized high tax states.

A guy making $100k in Texas ought to have the same exact tax federal burden of a guy making $100k in New Jersey. As it stands now, those two guys pay a different amount to the federal government. That is unfair. A state can raise state taxes will little impact on residents however it results in lower tax revenue to the US government and more revenue to the specific state.

High tax states hate giving up that deduction because they would effectively be giving up a subsidy.

dmode• 9 years ago

What about property tax deduction? Why isn't that on the table if you are concerned about fairness. Texas has some of the highest property tax rates in the country. Why not focus on that deduction?

nsxwolf5• 9 years ago

Don't you have to do more work to make a claim about who is subsidizing who? How much does each state receive in federal grants and aid?

And the guy in Texas has more money in his pocket than the guy in New Jersey no matter what. It's a weird thing to get hung up on. Nobody ever talked about the fairness of this deduction before. This was cooked up as a GOP talking point in some smoke filled room somewhere. Class envy as a Republican tactic is a curious development.

ohazi• 9 years ago

You get what you pay for.

California is able to spend my state taxes on things that I want, and the federal government gets to not pay for those things.

Texas has to spend federal dollars if they want similar things. Their options are either to not have nice things, or to spend more federal dollars than California does.

That's what the deduction attempts to account for.

api2• 9 years ago

Outside of just a big FU from the Republicans to largely Democratic states what is the end game?

I would bet that this is the end game. The entire tax plan seems targeted at "blue states," which already pay more Federal taxes per capita than "red states" when adjusted for Federal inflows.

At some point people will start asking: "why should we remain part of the USA? What do we get from Washington?"

I would not be surprised if the USA were to fragment by mid-century. The level of regional polarization we have today is unprecedented since perhaps the civil war.

Edit: I have a friend who's a little bit conspiracy inclined who thinks there's an agenda to fragment the USA. I find it hard to totally dismiss this notion given how politics is being played. There is definitely a far-right agenda to fragment the EU, so it's not an absurd notion.

orangecat• 9 years ago

And the mortgage deduction and state tax write off proposals are targeted at California / NY.

I'm sure targeting wealthy coastal liberals is a feature for many Republicans, but as nearly every economist will tell you the mortgage interest deduction really is awful and should be nuked from orbit. It's probably the most intelligent thing this Congress has proposed, even if it is by accident.

koolba• 9 years ago

That should be a clear enough example to the lawmakers that vesting should not be a taxable event.

Vesting has the unique property that before it occurs the shares are not yours and after it occurs, they clearly are (and can't be clawed back).

If you don't tax vesting, are you going to instead wait until the shares are sold to tax them? That would be very easy to abuse.

If this provision becomes law, startup and growth tech companies will not be able to offer equity compensation to their employees.

Nothing stops you from offering it. It's up to the potential employee to accept it, weighing the possible tax liability.

We will see equity compensation replaced with cash compensation and the ability to share in the wealth creation at your employer will be taken away.

In the vast majority of cases startup equity isn't worth the paper it's printed on. Paying their employee bonuses with cash would be a net win for their employees. The "losers" in this situation are established companies that arguably are already in a good position to pay out bonuses in cash (or at least include a cash component to cover taxes).

This has profound implications for those who work in tech companies and equally profound implications for the competitiveness of the US tech sector.

I really doubt that. The talent pool, networks, and legal infrastructure in the USA are second to none. That's not going to suddenly shift because of minute changes to tax law.

seattle_spring6• 9 years ago

I really doubt that. The talent pool, networks, and legal infrastructure in the USA are second to none. That's not going to suddenly shift because of minute changes to tax law.

Working for a startup is already immensely risky. If there was a practically guaranteed bankruptcy risk as a result of appreciating stock options, no sane employee would work for a startup anymore-- they would all go work for the big companies offering liquid stock. That, to me, is a very profound impact on our industry.

richardwhiuk• 9 years ago

Or startups could pay, you know, salary + bonus like the rest of the world?

JumpCrisscross3• 9 years ago

The "losers" in this situation are established companies that arguably are already in a good position to pay out bonuses in cash

If you can pay cash you can compensate your employees for the tax change. The losers are cash-poor companies. They will need to sell more shares, earlier, to pay for the change. That shifts leverage in early-stage negotiations from founders and early employees to investors. It also advantages, in the job market, firms with more cash over those with less cash.

maccaw• 9 years ago

There's so much inaccuracy in your comment that I feel needs to be addressed.

Vesting has the unique property that before it occurs the shares are not yours and after it occurs, they clearly are (and can't be clawed back).

That's not correct. You're vesting 'options' i.e. the option to purchase shares at a certain price. Not shares. Even once you buy the options they are not easily liquidated.

Nothing stops you from offering it. It's up to the potential employee to accept it, weighing the possible tax liability.

If it makes zero financial sense to anyone why would you offer it?

In the vast majority of cases startup equity isn't worth the paper it's printed on. Paying their employee bonuses with cash would be a net win for their employees. The "losers" in this situation are established companies that arguably are already in a good position to pay out bonuses in cash (or at least include a cash component to cover taxes).

No, the losers in this situation are early stage startups, and employees who want to work at those companies and get rewarded in the potential upside. At an early stage startup there is no 'cash' to pay bonuses. Even if there was cash, equity comp is incredibly more valuable in a company that sees any kind of success. Clearly you're bearish on equity based comp, so be it, but it has been my experience that equity is the primary avenue people see any financial success in tech.

If any semblance of this gets passed into law, and it effects ISOs, I think it'll be the end of Silicon Valley as we know it.

walshemj7• 9 years ago

Taxing on sale is farer or if say you get taxed on vesting and then 1 year later the company goes but do you get a tax refund I think not.

tome3• 9 years ago

If you don't tax vesting, are you going to instead wait until the shares are sold to tax them? That would be very easy to abuse.

Why would it be easy to abuse? Surely you can just set the tax basis of those shares to 0?

vmarsy• 9 years ago

If you don't tax vesting, are you going to instead wait until the shares are sold to tax them? That would be very easy to abuse.

would you care going in details on why this would be "very easy to abuse"?

In France that's how ISO works:

You have 2 taxable events:

- At exercise-time, calculate the gain here (between current date price and strike price).

- At sell-time, calculate the gain here (between exercise date price and current date price).

However, the first event, you don't owe any tax yet. You only pay the taxes for both exercise-time and sell-time taxes the year you sell the shares.

See the picture on [1] where "Prix d'exercise" = strike price; "Levée des options" = day you exercise the options.; "Vente des actions" = day you sell the stocks.

What is not 100% clear to me there is, what happens if the stock lost value between exercise date and sell date, can this loss offset the gains made on the first taxable event. In my opinion, to be 100% employee friendly, it should. But since the exercise date could have happened years ago, I'm not sure those can be offset since they aren't the same "type" of gains.

Anyways, with this system, in the case the company goes bankrupt and you never sold the stocks, at least you didn't pay taxes on money you never had in hands, you only loose the money you spent when exercising the options. I don't see how this can be abused.

[1] https://particuliers.societegenerale.fr/epargner/gestion_pat...

buckhx2• 9 years ago

Wow and I thought removing AMT was throwing folks with ISOs a bone.

seattle_spring6• 9 years ago

I'm 90% certain that "taxing stock options upon vest" only refers to non-qualified stock options. ISOs, which the majority of startup tech employees with incentive options get, would not be taxed upon vest.

RSUs and NQOs would fall under the new definition, and holders would be screwed. I just want to make sure we all have our definitions straight.

kelnos18• 9 years ago

This doesn't really affect RSU vesting much for publicly-traded companies. Under the current regime, RSUs are taxed on delivery; for a publicly-traded company RSUs are usually delivered at vest time.

I don't object to taxing NSOs at vest time all that much; for rank-and-file employees ISOs are the norm, and NSOs are usually for highly-compensated execs whose grants easily pass the ISO per-year vesting cap. They're the kinds of people who are likely to be able to afford these taxes without liquidity, and who are probably able to take advantage of a bunch of other tax loopholes anyway.

The downside there is for companies that give employees more than 90 days after termination to exercise their ISOs (which by law must be converted to NSOs after 90 days)... I imagine that conversion might trigger a taxable event under these new laws.

eldavido5• 9 years ago

I think the way we do options in startups needs a more fundamental rethink. I wouldn't be too sad if the current system falls on its face.

I like Buffett's proposal from a few years ago. They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money, after all.

What's really needed is a way some group of insiders in a company can transfer shares among themselves or outsiders. This would probably take a big change in securities laws to create rules around how unaudited equities could be traded. But I keep seeing these stories about AMT, employees leaving who never vest, golden handcuffs, etc., it makes me think we need to make private company stock work more like public company stock, somehow.

Another thought: Zuckerberg has said a few times he doesn't think going public was as bad as people said it would be. Maybe the solution is for companies to become public earlier and have investors operate more like PIPE shops or activists who just hold big chunks of company stock?

austenallred13• 9 years ago

That’s the point of options though - most of the time that “cash” doesn’t exist to be paid out in bonuses. Options are a bet that it will exist in the future.

Why do startups pay lower salaries than Facebook? Because Facebook throws around $200-300k salaries and doesn’t care. Startups can’t do that, so it promises a piece of the pie if the company becomes big and successful instead.

mooreds2• 9 years ago

Nor does the ability to "buy in" exist for normal employees unless the business is public or sets up some kind of ESOP.

eldavido5• 9 years ago

I don't think this is true anymore. I think this is one of those funny vestigial things that evolved in a different era.

If you think of a startup as a true "garage venture" with a few people toiling away trying to ship a product, maybe that's the right model.

That isn't really the model for SV entrepreneurship anymore, though, even though we kinda pretend it is. How it works today is, $8 million-dollar "seed" rounds, downtown office space, early-stage companies paying $150k or more for talent, incubators and signaling, etc.

Maybe one of those cases where the game has changed, but our mythos hasn't.

oneshot9083• 9 years ago

At this point, unless you're C-suite, most startups are a really bad bet compared to the BigCos paying out anywhere from $250K-$1M annually depending on your skill set and experience.

What's happening now IMO is that the hot talent has figured this out and they have accepted positions at Tesla, Salesforce, Google, Facebook, Apple, or Amazon. That said, I know someone who walked away from a $10M package over 4 years to be the CTO of his startup. I wouldn't have, but everyone has to follow their path, right?

s73ver_10• 9 years ago

Yeah, but all the risk of that bet is put on the employee. The employer faces none of it.

conanbatt11• 9 years ago

The main problem i see with the equity system is that its absolutely intransparent in terms of cap tables and preferred shares.

To the very least, if companies were forced to give out cap tables, or at least, a calculator that gives you your payout based on the company sell out cases, you would be able to measure it.

Right now, the calculation is complicated and obsfucated for employees. Lets say you have 1% of stock and the company sells at 100m. You are most likely not going to get 1m because of preferred shares. Preferred shares are truly a cancer on the system.

walshemj7• 9 years ago

Or like in the uk for approved (ie tax friendly) enforce the issuing of the same shares to employees as the others.

GeneralTspoon2• 9 years ago

It seems completely absurd to me that preferred shares exist, and one of the reasons I always hesitate whenever I'm offered equity.

For anyone curious, here's a good explaination: https://www.capshare.com/blog/how-preferred-stock-affects-th...

They basically shift a lot of downside risk from the preferred share owners (usually a VC firm I guess) to the founders and employees in the startup, which in theory makes them more likely to invest in more startups. But in the long term, this seems like it consolidates captial (which is generally a bad thing IMO).

It seems as though it just makes investing in any startup that's expected to at least be acquired at some point a 'risk-free' investment.

Anyone have any thoughts on why this might be a good thing?

maerF0x0• 9 years ago

What's really needed is a way some group of insiders in a company can transfer shares among themselves or outsiders. This would probably take a big change in securities laws to create rules around how unaudited equities could be traded.

Most option/stock agreements give the company right of refusal and they can block sales

They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money

Doesnt work for private companies, there's no market to buy them in

Maybe the solution is for companies to become public earlier and have investors operate

I've recently been thinking about the ramifications of more and more of our economy being privately traded. It means that many groups of people are unable to use that slice of the economy to back things like retirement funds. Also can technically lead to a run on equity where folks are trying to save but are just competing over the same limited pool of assets. Articles like [1] are indicating that the number of IPOs per year are dwindling. Maybe a law that says companies valued over $THRESHOLD must be public?

[1] http://fortune.com/2017/01/20/public-companies-ipo-financial...

kelnos18• 9 years ago

> They don't grant stock, they simply pay cash (bonuses) and if employees want to buy in, it's their money
Doesnt work for private companies, there's no market to buy them in

Personally I'd like to see more employee profit-sharing arrangements. Difficult for a lot of companies though that run at a loss for years.

johnhess• 9 years ago

Link to Buffett's proposal?

eldavido5• 9 years ago

It's from the 2016 earnings letter. He was making a completely different argument, namely, that accounting that ignores options expense is bullshit (many companies still present this separately in their earnings reports).

The relevant section is as follows: "To say “stock-based compensation” is not an expense is even more cavalier. CEOs who go down that road are, in effect, saying to shareholders, “If you pay me a bundle in options or restricted stock, don’t worry about its effect on earnings. I’ll ‘adjust’ it away.” To explore this maneuver further, join me for a moment in a visit to a make-believe accounting laboratory whose sole mission is to juice Berkshire’s reported earnings. Imaginative technicians await us, eager to show their stuff.

Listen carefully while I tell these enablers that stock-based compensation usually comprises at least 20% of total compensation for the top three or four executives at most large companies. Pay attention, too, as I explain that Berkshire has several hundred such executives at its subsidiaries and pays them similar amounts, but uses only cash to do so. I further confess that, lacking imagination, I have counted all of these payments to Berkshire’s executives as an expense. My accounting minions suppress a giggle and immediately point out that 20% of what is paid these Berkshire managers is tantamount to “cash paid in lieu of stock-based compensation” and is therefore not a “true” expense. So – presto! – Berkshire, too, can have “adjusted” earnings."

Full pdf: http://www.berkshirehathaway.com/letters/2016ltr.pdf

I guess the difference is that big scaled companies have revenues, and cash, whereas small companies don't. But I don't think that's so true anymore in a time when companies are doing nine-figure investment rounds. I'm not saying it's typical, but I do think this model of "bundled options+cash" has got to go.

austenallred13• 9 years ago

The importance of this change can’t be understated; this effectively kills compensation at startups in the form of equity, and would make startups completely unable to compete with incumbents.

Anyone that has options at a company that grows quickly would be paying tens or hundreds of thousands in taxes to keep their equity, which is still effectively a very risky bet that a company will end up huge.

No one would want options anymore, which would make it impossible for startups to compete with large, cash-rich incumbents. That should be the last thing you want if your goal is for an economy to grow.

ihsw23• 9 years ago

While this is an unintended consequence, how do you otherwise tax the massive equity compensation packages offered to executives? It has to be across the board.

kyleblarson• 9 years ago

It's already taxed whenever they exercise.

toast0• 9 years ago

Honestly, this feels like an accounting trick to recognize taxes sooner. This helps the early year or years of the budget balance, at the determent of the later years, which usually don't count for budget scoring.

In this case, it also gives a fair number of people a bigger tax headache. In some cases, taxing earlier may mean future gains become capital gains when they may have been ordinary income; that's not good for tax revenue, even if you get some of it sooner.

kstrauser• 9 years ago

I don't think it's an unintended consequence. I think it was meant to punish Big Tech for their resistance to the Republican party in the 2016 election.

stale2002• 9 years ago

How about taxing the options when they are actually sold, and gains are actually realized?

oneshot9083• 9 years ago

I think the way to look at this is as yet another attempt by dying but deep-pocketed industries to buy themselves a few more years of oxygen whilst their executives either retire and GTFO or they desperately pivot to the scary new age of Tech and AI that is already upon us.

IMO it's not partisan, it's just business.

further, this already happened once with AMT and Dotcom 1.0, leaving a bunch of rank and files with huge tax bills for profits they never actually reaped.

neom3• 9 years ago

no new money millionaires disrupting the status quo, please.

logfromblammo6• 9 years ago

What if your goal is for technical talent to prefer companies that make parts for the F-35 that actually function as intended, instead of companies that could be described as "Uber for cat-sitters" or "the Snapchat of Etsy-linked Tumblr posts" or "Pets.com with more tulip bulbs" or "like Facebook, except fronting for GRU instead of NSA"?

In that case, it would meet that goal very well.

What a pity it is that the technical talent, who might prefer lucking into big piles of windfall cash by working for the right unicorn, has no big national organization to lobby in favor of our interests, and speak out against this type of change. (If you're one of the folks that knee-jerk downvotes any mention of tech worker unions, that's what I'm talking about, so let's get that click out of the way.)

austenallred13• 9 years ago

In this instance the exchange you would have to make would be crippling startups and small businesses, which is where the vast majority of the growth of the economy happens.

As an aside, how many companies do you see actually building Snapchat for Etsy-linked tumblr posts? I see that criticism of Silicon Valley all the time, yet despite being in the heart of it I rarely see that kind of company. I’d guess an order of magnitude more money is going into building human transporting drones and supersonic jets than into the silly stuff people love to rail on the Valley for.

Look at the list of startups that just came out of YC and you’ll see maybe one or two companies that fit that kind of mockery.

s73ver_10• 9 years ago

At the same time, wouldn't that talent be equally wasted at "Uber for cat-sitters"?

nsxwolf5• 9 years ago

Can I give back my options if this bill passes? I'm literally sick now reading this. What I thought was a great part of my compensation package is literally going to bankrupt my family.

austenallred13• 9 years ago

Yes you can just give them back, but I would be shocked if the bill passed this way.

This clause wasn’t in the House version of the bill. Call your senator.

heimidal3• 9 years ago

Existing grants would be grandfathered in, so giving them back may not make much sense. Future grants, though, should just be killed and you should negotiate for higher pay.

nhumrich2• 9 years ago

This only affects RSUs and NSOs. I assume you have ISOs

quickthrower2• 9 years ago

Yes, it would be like here in Australia, where I paid higher rate tax on non-public shares allocated to me. I didn't even have the luxury of waiting until they vest! I think if you leave a company before vesting you have to try and get that tax money back from the ATO.

In fact, you could, in theory, bankrupt someone by giving them enough shares.

I think they may have changed this for small enough companies, but still, it's a bad thing aimed at taxing middle classes not the rich. The rich don't earn shares as part of payroll, I imagine.

Buge7• 9 years ago

The rich don't earn shares as part of payroll, I imagine.

In Australia or the US? Because they do in the US.

exelius4• 9 years ago

No one would want options anymore, which would make it impossible for startups to compete with large, cash-rich incumbents.

You're right; nobody would want options. So we have to start paying people in actual shares if we want to give equity. Which means you have to give employees way more of the company than deep-pocketed investment bankers who will still invest -- despite their temper tantrums to the contrary -- because there are very few companies that can absorb a nine-to-ten figure investment and do something productive with it.

Just because the system as it exists right now would be destroyed doesn't make this a bad change. The system right now is overly complicated, leads to workers abandoning in-the-money options or staying at a job they hate, and is heavily slanted towards early employees.

But the current model of venture financing is largely dead regardless of whether this change goes through. It's already being replaced by cryptocurrencies / ICOs, which seem like a far more sensible method of issuing restricted stock in excess of the SEC's limitations (since the right crypto / wallet scheme for something like this would not be anonymous). I think ultimately, cryptocurrencies are going to replace RSUs, but the cryptocurrencies that replace RSUs will probably have many of the same governance restrictions as RSUs.

How we treat them for tax purposes is a different problem, but it should make the RSU liquidity problem less troublesome (e.g. you can sell some of your crypto-RSUs back to the company in exchange for ETH/BTC, then convert back to USD and pay your taxes).

rsynnott2• 9 years ago

So we have to start paying people in actual shares if we want to give equity.

People wouldn't want that either; they'd still have to pay tax on shares that were, for practical purposes, worthless at time of issue (and time tax due) and would statistically probably always be worthless.

Under this system, you'd really have to abandon compensation with stock of any sort for non-publicly traded entities.

acchow• 9 years ago

So we have to start paying people in actual shares if we want to give equity

This is also a big gamble if you're given shares in a non-public company. You pay taxes on these shares at vesting - not only have you reduced your liquidity until IPO/exit, but these shares could end up being worth nothing if the company fails.

tschellenbach4• 9 years ago

The problem with giving employees shares is that they would either need to pay for those shares or be taxed on their value. This would effectively limit early stage startup participation to those with a nicely filled bank account.

dmoy• 9 years ago

But the current model of venture financing is largely dead regardless of whether this change goes through. It's already being replaced by cryptocurrencies / ICOs, which seem like a far more sensible method of issuing restricted stock in excess of the SEC's limitations (since the right crypto / wallet scheme for something like this would not be anonymous). I think ultimately, cryptocurrencies are going to replace RSUs, but the cryptocurrencies that replace RSUs will probably have many of the same governance restrictions as RSUs.

Is this true? I thought (perhaps incorrectly, naively) that one of the whole points of private equity being locked down and unable to sell/liquidate was just that - so that it can't be sold/liquidated. Any solution that makes it liquid goes against one of the original purposes, and thus isn't likely to happen.

clairity• 9 years ago

yeah, this is old guard trying to put up barriers against up-and-comers in tech, under the guise of sticking it to the elites (ironically).

equity compensation has plenty of risks, which is why the timing of taxes gets complicated. the value of the underlying asset needs to solidify enough (meaning there is a liquid enough market for the equities) that it can be (partially) liquidated and used to pay the tax. but the variance in the liquidity over time is so high that it's nearly impossible to properly predict when the tax man should come knocking on the door.

jsonne2• 9 years ago

I mean not to be a jerk about it but so what? It seems like giving out high risk stock options is a bad deal for workers overall. If the goal is to grow the economy wouldn't paying a rank and file employee more fairly be better for more people and the economy as a whole?

tschellenbach4• 9 years ago

I know many early stage employees that achieved significant financial upside by working at early stage startups. Working at an early stage startup is probably the only low-risk way of achieving that. Creating your own startup is of course always an option but requires significant upfront capital, a huge opportunity cost in terms of how much you work and a significant cut to your salary. (if anything).

beavisthegenius• 9 years ago

I guess they'll have to pivot or be disrupted.

cyberpunk0• 9 years ago

Equity is imaginary fugazi. you might as well be accepting empty promises. I wouldn't want it even now

dopamean• 9 years ago

Yeah so imagine having to pay taxes on something you think is "imaginary fugazi."

loeg4• 9 years ago

would make startups completely unable to compete with incumbents.

They already are mostly unable to compete with larger companies on total compensation. Startup equity is worthless unless you win the lottery.

https://danluu.com/startup-tradeoffs/

thanatropism• 9 years ago

The Joel on Software post cited on your link is just too good.

https://www.joelonsoftware.com/2008/05/01/architecture-astro...

Jeez, we’ve had that forever. When did the first sync web sites start coming out? 1999? There were a million versions. xdrive, mydrive, idrive, youdrive, wealldrive for ice cream. Nobody cared then and nobody cares now, because synchronizing files is just not a killer application. I’m sorry. It seems like it should be. But it’s not.

ryandrake• 9 years ago

I don't know--maybe startups and small businesses will just have to go find a better way to be competitive compensation-wise. Today, they get to lure people in with an insufficient cash salary plus "free" equity lotto tickets, perpetuating the "jackpot or nothing" environment. I don't know what the solution is but it would be nice if a creative alternative could be found.

nhumrich2• 9 years ago

Anyone that has options at a company that grows quickly would be paying tens or hundreds of thousands in taxes to keep their equity, which is still effectively a very risky bet that a company will end up huge.

No. Most companies give their employees ISOs, which arent affected by this bill. So it would actually be 0 change to the employees. What this affects is the investors or potentially the founders of a startup

BeetleB• 9 years ago

What this would mean is every month, when your equity compensation vests a little bit, you will owe taxes on it even though you can’t do anything with that equity compensation.

I'm not sure what he means with regards to RSUs.

When my RSUs vest, I am taxed on them currently. And I can do whatever I want with them. My employer gives me RSUs with a 4 year vesting period - a quarter vests every year. And every year a quarter of those stocks are given to me to do whatever I want with them.

Perhaps he was referring to something other than RSUs? Or it is only relevant for private companies (which all startups are)?

t_fatus4• 9 years ago

You can do everything with them if they are publicly traded, if not what are you going to do ? If you're working in a early stage company which can see its valuation goes north (probably one of the reasons you work there instead of google btw) you could try to convince someone to buy some of your stock each month to pay for these vested shares you just get ?

neom3• 9 years ago

This is awful. Now, if your founder/lawyer was kind, you CONVERT the ISO stock to NSO upon leaving the business and increase the excursive window, so they are not NSOs till the employee leaves the business. (NSO tax per vest, ISO tax on exercise)

The way it works in my business is: you have regular ISOs, you vest, you leave, we convert to NSO and give you 8 years to buy them. You're not vesting anymore, so you sidestep the vesting tax associated with NSO, and you pay the cap gain in 8 years. This is the most employee friendly way to structure things as not everyone has liquidity to deal with what they have earned (both buying the grants and the tax associated with buying the grants).

Under the new plan, the rule around NSOs being taxed per vest (remember when you leave you're not vesting anymore) will be applied to all types of employee stock option compensation. That's madness. Personal opinion: On the plus side, maybe salaries will go up and stock grants will go down (imo unhealthy). It will also push more 409a. :\

(Edit- My COO says: julie [11:57 AM] that provision is already being softened in the latest amendment btw)

hamburglar4• 9 years ago

I can suggest another employee-friendly way, which my previous company did for me as a one-time thing, but I would like other companies to learn from and make more common: They allowed me to exercise my options and then, so I could cover the taxes, arranged a sale between me and one of their other investors for a small portion of my shares. It worked out beautifully.

sk5t5• 9 years ago

What is your reference on NQSO taxation at vesting under the current rules? AFAIK they are today taxed at exercise; ISOs, in contrast, are not necessarily taxed at exercise, but may trigger AMT.

nsxwolf5• 9 years ago

Anyone know exactly what "Performance Units" are, and if they would fall under this?

umanwizard2• 9 years ago

My RSUs have always been taxed on vest -- what am I missing?

seattle_spring6• 9 years ago

Is your company publicly traded? The OP is referring to issues when the stock is illiquid.

umanwizard2• 9 years ago

Yes it is publicly traded. So, how does it work with privately traded companies. Talking about RSUs, not options. What is the difference between "release of the underlying shares" and "vest" ?

xfactor973• 9 years ago

I don’t quite follow how this is different. When I got rsu’s at my former company they sold a bunch at every vest date to pay for taxes. Isn’t that the same as what they’re talking about here?

seattle_spring6• 9 years ago

Was your company publicly traded? The OP is referring to issues when the stock is illiquid.

kelnos18• 9 years ago

RSUs are a little different: they're currently taxed on delivery, not vest. When you work for a public company, vest and delivery dates are nearly always the same, so it seems like they're being taxed at vest time.

api2• 9 years ago

This is pretty awful. It would kill the ability for startups to compete with large companies for top talent. There is no way startups can afford the salaries that Google, Facebook, etc. can offer.

It would also break the machine that mints new angel investors. A huge percentage of angel investors are people who got rich off options/stocks in growth companies.

This really seems explicitly anti-entrepreneurship and pro incumbent mega-corp.

Of course it also might have another (possibly unintended and not all bad) side effect: to drive startups out of Silicon Valley and other high salary high cost of living enclaves. A startup can offer very competitive salaries in many other places. Put a startup in Ohio or Michigan and $80-$100k can get you the best talent available on the local market... especially if you also offer much more interesting problems to work on than the enterprise salt mines that tend to dominate IT employment in those places.

ubernostrum• 9 years ago

It would kill the ability for startups to compete with large companies for top talent.

Not to go on too much of a tangent, but: the fact that companies think they're competing with Facebook and Google for the same tiny pool of people, and that that tiny pool of people is the "top talent", is one of the big problems in our industry.

See things like this article:

https://danluu.com/programmer-moneyball/

Or this comment:

https://news.ycombinator.com/item?id=11290662

trothamel2• 9 years ago

Isn't this a change that makes the tax code fairer? It seems like options and RSUs have value associated with them. At the very least, the person who is receiving them considers them to have value. Stock options are traded on markets, and priced some how.

Part of the new tax plan seems to be trying to lower the tax brackets, in exchange for preventing people from avoiding taxes. That's why it seems to be doing things like taxing these options and the free food some companies supply their employees.

It isn't clear why income shouldn't be taxed just because it's supplied in a different way.

austenallred13• 9 years ago

The value associated with them is illiquid. I can’t necessarily sell my stock options for what they’re “worth,” so taxing them at that level makes them pretty much worthless.

It’s already taxed when I sell them - when I get dollars that I can spend. Taxing before then is (I hope) an oversight.

kolbe6• 9 years ago

Would you be cool if you got taxed on the income tax scale upon selling them?

conanbatt11• 9 years ago

and the free food some companies supply their employees.

This is a long standing question. Are costs of benefits like these one not taxed in the US?

The implications of not taxing that is huge.

t_fatus4• 9 years ago

comparing free food, which you directly benefit, and RSUs seems really unfair.

gnopgnip• 9 years ago

Free food is taxed unless it meets certain qualifications, the biggest one being that it is for the convenience of the employer.

t_fatus4• 9 years ago

Options and RSUs gain value the day you pay for the underlying stocks, not the day you're allowed to buy a stock which could later in time become worthless. don't forget they're aimed at employees so they can share the value created by the company they work within, and that these employees will pay taxes in time when they extract any value from their companies

trothamel2• 9 years ago

Don't they gain value at both times? I mean, stock options are something people pay for.

kolbe6• 9 years ago

If they don't have any value, then you shouldn't have any problem with them going away. You obviously consider them valuable, or else you wouldn't be defending them.

kelnos18• 9 years ago

Isn't this a change that makes the tax code fairer? It seems like options and RSUs have value associated with them. At the very least, the person who is receiving them considers them to have value. Stock options are traded on markets, and priced some how.

By that logic, you should have to pay tax on publicly-traded stocks that you own daily, every time the price goes up, even if you don't sell it.

Taxing unrealized gains is insanity. How does it make sense to levy a tax on income that cannot be converted into money?

Part of the new tax plan seems to be trying to lower the tax brackets, in exchange for preventing people from avoiding taxes.

That's a bit naive, if that's the case. I would never expect people to opt out of legal means to reduce their tax burden.

herodotus• 9 years ago

What does it mean for an RSU to "vest"? My understanding of RSUs is that it means the company will give you some shares if you still work there at some specified date. Vesting is a stock option concept - the time at which you can choose whether or not to sell some of the granted shares. Which means that you can sell some shares to pay your taxes when the shares vest.

Is the current proposal meant to tax the RSUs when you are told you will be getting them?

closeparen3• 9 years ago

My RSUs vest at the latter of the time-based condition (schedule) and performance-based condition (company liquidity event). The proposal is to make this taxable income purely at the time-based condition, when they may still be illiquid.

bgentry2• 9 years ago

Here is a more detailed analysis of these parts of the proposed tax bill: http://bakerxchange.com/rv/ff0034eed7a7d447f644f491d94caddcb...

ransom15383• 9 years ago

"The current draft of the Senate Tax Reform Bill would tax stock options and RSUs upon vesting."

Ok. I wouldn't panic here. Calm down.

How shares are vested is up to the board. So, if this were to pass I would just walk into the CEO's office with a few employees and ask to change how shares vest to: "Upon the vesting schedule AND a written letter from the employee requesting vesting. If the letter isn't submitted the shares are not vested." So, if I don't send a letter to the board the shares do not vest. If I want to vest 12 months and leave, I would just submit the letter. Problem solved. How shares are vested is totally made up. You could have them vest when you wear a purple shirt on tuesdays.

seattle_spring6• 9 years ago

Why would someone from a large publicly traded company panic? Shares already are taxed upon vest there.

ransom15383• 9 years ago

Yep. That isn't about publicly traded companies. The only people that would panic is if you are in a startup that cannot exercise.

lgleason• 9 years ago

I would also add a clause where if you meet the timeframe to vest, you can exercise that within a certain time of leaving the company irregardless of the reason for leaving (IE: termination for cause etc.) to ensure that employees get what they earned.

ddlatham• 9 years ago

I doubt that it's that simple. For tax rules, it's likely more about the notion of when the employee has the effective right to it. If the employee has the right to it, via being able to write a letter requesting it, then it's already vested from the perspective of the IRS, regardless of what word games you play.

ransom15383• 9 years ago

[deleted]

macspoofing• 9 years ago

Maybe. But keep in mind the IRS isn't stupid, and they aren't simply passively taking the letter of the law. They are very much an active participant. For example, they may interpret option vesting in a different way then you just did, and they may prohibit blatant ways of getting around it.

ibejoeb2• 9 years ago

It really isn't "made up." Issuing equity compensation triggers all sorts of activity. The notion of vesting is that the individual will come to own shares after the conditions are met sufficient to lift the restrictions. The restrictions often include time in service to company ("after 1 year of service, you will earn 100 shares"), performance toward some specific goal ("prototype passed QA by Q3"), and financial performance of the company ("EPS increased by 2%").

In these arrangements, the recipient is agreeing in advance to accept equity as compensation. The company must account for that essentially as if it were cash, and it becomes an income statement item just like any other compensation expense.

The economic event, for both the issuer and the recipient, is the moment when there is no material risk of forfeiture. In simple terms: if the company can't take them away from you, they are yours.

closeparen3• 9 years ago

If the company can’t take them away from you but you’re contractually obligated not to sell for 18+ months, they aren’t really yours.

bnjmn2• 9 years ago

Here's the statement I plan to read to my representatives:

I live in Greenpoint, Brooklyn. I work for a small startup of less than 30 employees.

Three years ago I left a large, publicly traded tech company to take this job, because of the potential I saw in the work the startup was doing.

I took a significant pay cut when I joined the startup, a decision that was justifiable only because of the distant future value of the incentive stock options that the startup promised me.

It is my understanding that the current tax bills on the floors of the house and the senate would tax these options when they first vest, long before I could possibly sell them to cover my tax bill.

If I am wrong about this, I would appreciate any clarification you can provide, ideally written into the text of the bills themselves.

If my understanding is correct, I honestly don't know how my startup, or other small companies like it, will be able to compete with wealthy public tech companies as we try to hire new employees in an already extremely competitive market.

I struggle to understand how draining talent from the most innovative small tech companies can possibly be construed as a good thing for our economy.

Thank you for your time.

oaijdsfoaijsf• 9 years ago

Maloney is a Democrat, though, and will likely vote against the tax bill with or without your say so. Both of our senators are also Democrats. Not that it wouldn't be helpful to provide them with ammunition against the tax bill, just saying that this is not really going to move the needle much in terms of actual votes.

JonFish85• 9 years ago

It may be an interesting exercise to think of how this can be turned "against" you. If you wanted to play armchair politics, you could spin this:

- Highly paid engineer walked away from a 6 figure salary

- Takes a job at a small company where he gets equity that could potentially be worth millions.

- Complains that he may have to pay taxes on a significant portion of his compensation.

Put those together, and you have someone probably still making more than double the national median wage complaining that his favorite tax loophole is being closed. Meanwhile the local plumber / school teacher / single mom is struggling to make ends meet; why shouldn't you pay your fair share so that they can get a tax break?

FWIW, this is just an exercise, I'm not saying this is true. Just something to keep in mind though, that many (most?) of the people on HN are being paid significantly higher than most Americans, and complaining that their stock is being taxed differently isn't going to garner much support.

bnjmn2• 9 years ago

Thanks for the thoughtful feedback!

kelnos18• 9 years ago

I think the "easy" rebuttal to your third point/counterargument is that's not what's actually happening: you're being forced to pay taxes on vapor. No one is objecting to paying tax when stock is sold; that's normal and reasonable. It's just crazy to expect people to pay taxes on something that cannot be sold.

gms• 9 years ago

All a bit moot since companies aren't going public anymore, no? ;)

sidlls• 9 years ago

I don't think I'd ever accept RSUs that I could not instruct my broker to liquidate to cover taxes immediately for. I'd either turn down the offer or require more cash salary instead. I've never worked in a place where RSUs weren't released simultaneously with vesting so that the broker could liquidate them for taxes on the gains realized by the value-at-vesting of the stock (the proceeds of the sale are also taxed).

As that's only applicable to publicly traded companies, I don't think this bill is a good idea. I think the start-up world's use of options and equity is not healthy, but there's a big difference between a person whose options/equity grants are a relatively small fraction of his compensation and true stakeholders/executives who have a significant fraction (often the majority of it) of their compensation in the form of equities. The tax code shouldn't treat these workers the same.

spullara2• 9 years ago

The text of the bill specifically says that it is not intended to apply to statutory options (ISOs).

From page 123:

"However, it is intended that statutory options are not considered nonqualified deferred compensation for purposes of the proposal. An exception is provided for that portion of a plan consisting of a transfer of property described in section 83 (other than nonstatutory stock options), or a trust to which section 402(b) applies, or relating to statutory options under section 422 or 423 for which there is no disqualifying disposition."

StevePerkins• 9 years ago

Do you have a link to the actual bill?

spullara2• 9 years ago

Link to the bill with before / after descriptions. Starts at page 116:

https://www.finance.senate.gov/imo/media/doc/11.9.17%20Chair...

nerdsaresingle• 9 years ago

As a startup employee, I love this rule as this can help CEOs to go public sooner than later. Today VCs are the capitalist who take away all the growth of a tech stock till series’s D and then public pays a premium. If this rule leads startups to go public at 100Mish range instead of 2-10b, this could be great.

kolbe6• 9 years ago

Serious question here. My impression is that Silicon Valley leans heavily liberal, and as such most people there believe in a progressive tax structure and generally lean towards wanting the government to receive more revenue than conservatives. If my impression is wrong, then please correct me.

With this in-mind, why is there such outrage about taxing option and RSU income? It's still income. And the current situation could not be described as anything but a tax break for the "wealthy," at least insofar as Obama liked to define people as wealthy. It's an asset that you receive in connection with your labor. It's income. And you don't have to pay income tax on it (iirc, it's mostly cap gains when exercised). And it's mostly given to people who already make $150k+ a year anyway.

I cannot reconcile this outrage over still having a tax dodge (but not as good of one) with the political leanings of SV.

bpicolo• 9 years ago

The problem is that it's explicitly not real income for those working at companies which aren't publicly traded. For publicly traded companies, you typically sell-to-cover at vesting time, so you're already doing this sort of thing usually.

For private companies, that's not an option, so you would have to pay tax at vesting time for options you could quite possibly never have an opportunity to sell.

heimidal3• 9 years ago

It's not income if you never exercise the option.

Imagine starting as a senior-level manager at a company that's a few years into its life. They provide you with a salary of $150k/year and 100,000 options at $1 with a standard four-year vesting schedule. In the first year, the company's fair market value increases to $2/share. Your tax liability just increased as though you made an extra $25k, so you'll need to come up with ~$8k to cover.

If the company sees its value increase 2x per year for all four years, you'll be on the hook for taxes on $675k having only made $600k in actual dollars. Good luck scraping together taxes to cover adjusted income of $525k in year 4 if the company doesn't go public.

If the fair market value falls after you vest but before a liquidity event, you never saw a penny of extra liquid assets but still had to pay tens or hundreds of thousands in taxes.

This will bankrupt people.

kolbe6• 9 years ago

That sounds no less fair than someone who bought a home for $100k in 1980 who's seen its value appreciate to $5mm, and now has to pay $50k a year in property tax.

That sounds no less fair than a family liquidating its estate because they can't afford the estate taxes.

That sounds no less fair than a health-conscious person taking care to never drink or do drugs paying 10x more for socialized healthcare to pay for the ailments of an obese alcoholic.

I doubt I need to go on, but the point is that taxation sucks. And it's completely hypocritical of someone to want to levy these burdens onto someone else while they themselves become indignant over a tax loophole of theirs being tightened (not even closed). It's even worse that the people who are getting indignant over it are some of the wealthiest in the United States, while at the same time, you want to stick a guy who earns $50k a year with an extra $3k with the ACA.

I do admit that the story you provided sounds like it sucks more than average, but in reality, a bank will just give you a loan to cover the taxes. No one is going bankrupt. And if the shares end up going to zero, you get to have capital carryover losses just like everyone else whose investments lost money.

But the point is that taxes, when you actually have to get down to it, suck. And if you're being truly democratic, you should try to empathize with all taxpayers in the same way that you think about your own taxes.

abvdasker• 9 years ago

RSUs issued by a private company are not income because they are completely illiquid. Taxing RSUs at vest makes no sense because their value could change after they vest but before they are converted to liquid equity.

In practice what this means is that maybe you get granted $1 million in RSUs by the private company you work for and pay hundreds of thousands of dollars in taxes. The private company goes bankrupt and never goes public or get acquired and the RSUs become worthless. You don't get those taxes back and you never got the $1 million.

ProblemFactory• 9 years ago

why is there such outrage about taxing option and RSU income?

There is no outrage, or even opposition to taxing income from selling options and RSUs.

The problem arises because in some situations options and RSUs are considered "income" as themselves, not a potential to make income when they are sold.

You get some options in an early-stage startup, and have to pay tax on that. But you can't actually sell your options - there is no market, and often you aren't even allowed to sell them before the company is acquired or goes public. There is still a good chance that the company will go bust before either of these happens.

So you have to pay a tax bill years before you actually earn income, and potentially without ever earning income from your options.

kolbe6• 9 years ago

Liquidity is not a requirement for a transfer of an asset to be considered income. If your company paid for your apartment, that's income, despite the fact that it may be impossible for you to sublease it.

Certainty of future value is not a requirement for something to be considered income. You get paid in dollars all the time, but that's just an asset with fluctuating value.

There are several loopholes that get around the definition of income to defer or avoid taxes for certain types of income, but that's exactly what this is: a loophole for the wealthy. And I have no problem with SV employees enjoying tax breaks. I just can't reconcile SV's love of taxing other people, avoiding it for themselves, and still claiming this is a moral, rather than selfish, stance.

jeffdavis2• 9 years ago

The problem is taxing illiquid gains. If they are liquid, vesting time is the logical time to tax them.

Conversely, taxing at exercise time doesn't really make sense for illiquid gains and more than vesting time does. People have problems with this now.

The real challenge would be to fix this without creating an incentive to keep gains illiquid when they could be liquid.

lowbloodsugar• 9 years ago

"And that would be the end of equity compensation in startups as we know it."

Good. This entire industry is a lottery. We all laughed at the slot machines in the hospital in the movie "Idiocracy". "You could win free health-care!" And yet we're all hoping to win a life of luxury on the start-up lottery.

dberg• 9 years ago

if this passes (doubtful) do you all think we will see a massive surge in secondary market platforms ?

rb808• 9 years ago

Surely if you have options or stock in an illiquid company where you can't sell it - they are worth zero on a mark-to-market basis, so you dont need to pay tax on it?

If you can easily sell them for a price it makes sense that you pay tax on it.

Randgalt• 9 years ago

If only life were that logical. Under the rules as they are today, there are many scenarios where illiquid options/stock have a taxable event. People's finances have been ruined by this. I had a friend lose a house when he sold his company for stock.

dcosson• 9 years ago

Is there any chance companies could fairly easily adapt to this? For instance, grant 30% more equity per year than they otherwise would and buy back that 30% as it vests to cover taxes.

Edit: Now that I think about it those numbers don't work because it's an extra cost for the company to buy back your stock. So you end up with fewer shares with this scheme, but the company has also effectively paid off your "golden handcuffs". So in some cases it should even out in the end (you don't pay those taxes in a liquidity event) and in other cases it's actually better for the employee (you can afford to keep more of your equity if you leave before a liquidity event).

Dowwie• 9 years ago

Republicans don't cut deals with the commons. Their constituents can fit in a moderately sized ball room. Look to who will benefit by these changes and you will find the reason why they are planned.

Incumbents write PAC checks.

enra• 9 years ago

Fenwick also had some more information about the bill: https://www.fenwick.com/publications/Pages/Proposed-Tax-Refo...

sanj• 9 years ago

What happens when your vesting options are underwater?

Do you get to claim them against your taxes?

If so, given the rate of startup failures, this may be of net benefit to most startup employees.

kelnos18• 9 years ago

It's fairly uncommon that your options will be under water when they vest, even in a startup that eventually fails. The more common -- and more crappy scenario should this law pass -- is getting taxed on a paper gain, and then later the price drops below the tax basis due to a down-round or something else bad.

tschellenbach4• 9 years ago

I've had a similar tax issue which caused a few 100k in taxes on unrealized gains. That was not a happy day and I could barely pay the tax bill. In my case the issue involved moving from The Netherlands to the US. As far as I know the US is one of the only countries which taxes unrealized gains. In The Netherlands you only get taxed once you actually make the money. The VC industry is world class here in the US, but some of these tax rules are so backwards that they do real damage to startups and the economy as a whole.

nemo44x• 9 years ago

There is a provision in the House version of the tax bill to not tax the exercising of options until there is a liquidity event. In that case you wouldn't be taxed on the unrealized gain until you could sell the stock.

I still think with options it should be as you've pointed out a tax-free event until you actually sell the equity for cash.

VeronicaJJ123• 9 years ago

Lol. if this bill passes I am resigning from the current startup and joining Google or Facebook. This is idiotic.

tschellenbach4• 9 years ago

Yes, as a startup founder I'm quite worried about that exact effect.

sulam17• 9 years ago

I'm going to say something that may be unpopular. Hopefully my karma can handle it.

The latest analysis I saw of this from Fenwick says that this is only applying to non-qualified stock options. Employees get NSOs when you vest too much to get ISOs in a calendar year, based on the vesting schedule and value at the time of grant, not fair market value at time of vesting of the option. That limit is $100K, for people who didn't know.

[edit: clarified the issue of cap calculation since my original post was in error. The point doesn’t change.]

Who else gets NSOs? Non-employees, like directors, for instance.

This tax bill is pretty awful. However, it's not obvious to me that it destroys startup compensation -- ISOs will still be given to most employees, until you are getting too big for them, when you get RSUs, just like today. If anything your average tech employee will potentially do better -- I had to sell a ton of stock simply to pay AMT on the rest of the stock I exercised at my last startup. AMT goes away in this plan, so people won't have to deal with that issue.

hatred3• 9 years ago

You seem to be bringing up a really good point. From reading the article earlier, I was under the false impression that this applies to ISO's too but looks like it only applies to NSO's. What about non-public RSU's for late stage startups like Uber, Airbnb etc?

sulam17• 9 years ago

Those RSUs are a particular kind of promise, and it makes sense to use RSUs when the company has gotten very valuable because you hit the ISO cap pretty quickly and NSOs already have a tax-at-vest issue. My guess (IANAL) is that you'd just change the promise. "You will vest these RSUs when we go public and you can pay the taxes". I actually think there's _already_ an issue around this, because you can be vesting RSUs while the company is public but you are personally locked out and not allowed to trade them -- and yet you need to pay your taxes and the normal way to do that is to sell a portion of your RSUs. In the case I know of (Twitter), there was a special way of handling that on a one-time basis. I don't remember the exact details (it didn't apply to me), but they managed to work it out.

TimPC2• 9 years ago

It depends a lot on the pricing of that $100K. If that's based on price at time of vesting you run into big problems -- that's not how ISO's work currently but it's unclear exactly what is going to change in this bill. Say you get $50K/year in stock at the valuation based on the time you join the start-up and the start-up has on paper 10X growth in 2 years. In your 3rd year, your $50K of stock is $500K on paper so the last $400K would be over the $100K limit and immediately taxable even though you cannot sell the stock yet. If the tax is setup to make $100K of value at time of employment contract exempt from taxing as ISO's, then the problem is far smaller as the tax events are predictible and manageable.

sulam17• 9 years ago

I tried to be clear above -- the cap is based on the grant value, not the vested value -- ie it is strike price, not 409A (or other) exercise value.

Really, if you think about it, it could only be this way. You can't predict the future value of your company. If I give you an ISO grant now, but the company doubles in value next year and puts you over the cap, we're in a pickle.

pcl• 9 years ago

Per the article and my understanding from other secondary sources, the tax-at-vest clause applies to RSUs as well as NQSOs. RSUs are frequently issued by companies that do not have a liquid market. So, tax-at-vest is still problematic for that class of employee compensation.

djrogers2• 9 years ago

One would assume that companies would stop doing this and issue ISOs instead.

ccheever• 9 years ago

Do you have a link to this analysis? I couldn't find it online.

slapshot• 9 years ago

https://www.fenwick.com/publications/Pages/Proposed-Tax-Refo...

The proposed bill leaves Section 422 of the Code, governing the taxation of ISOs, untouched, apparently exempting it from new Section 409B. As a result, ISOs may continue to offer employees eligibility to receive favorable tax treatment by deferring taxation until sale

js2• 9 years ago

That seems correct:

However, it is intended that statutory options are not considered nonqualified deferred compensation for purposes of the proposal. An exception is provided for that portion of a plan consisting of a transfer of property described in section 83 (other than stock options) or which consists of a trust to which section 402(b) applies.

Page 209 of https://www.jct.gov/publications.html?func=download&id=5031&...

But I'm not sure how this impacts ISOs with an 83(b) election.

sulam17• 9 years ago

I think in an 83(b) you haven't had a gain, same as today, so there's nothing to tax.

hedora• 9 years ago

It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant. (Yes, this rule is terrible for planning, because you don’t know what fraction of your shares are ISOs until they vest).

Today, ISO’s are commonly given to engineers at pre-IPO startups. Nothing says they have to go to execs. Those engineers end up holding them for years before they can exercise, so $100K is a small fraction of a normal Silicon Valley startup, when you divide it out. Many startups take 6-10 years to IPO these days.

Source on $100K cap: stock plan admins at work, and also this article: http://help.capshare.com/knowledge-base/what-is-an-iso-100k-...

Please do not comment on technical nuances of the tax code you do not understand. Misunderstandings around this stuff bankrupts people all the time. (especially the type of people that hang out here!)

jalonso5103• 9 years ago

"It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant"

This is not correct. The $100k threshold is calculated based on the fair market value of the option at the time of grant, which by definition is the exercise price. So you calculate how many shares you will vest in each year, multiplied by your exercise price, and as long as that is under $100k you are not over the limit and your option remains an ISO. If you're over, then the portion that exceeds $100k is treated as an NSO, but you can still get ISO treatment on the other part.

I'm a startup lawyer and having worked with 100+ companies on their options, it's really not that common to get tripped up on this.

sulam17• 9 years ago

I just had to go double check this, because my statement above is based on actual experience.

The $100,000 limit is calculated using the fair market value of the stock for which the options are exercisable, as of the grant date...

IOW — value at time of grant, not time of vest.

sulam17• 9 years ago

Please do not comment on technical nuances of the tax code you do not understand.

cough. Sound advice, sound advice.

dnautics• 9 years ago

With the caveat that I know nothing about tax law, i feel like it's also terrible because it's procyclical for the employee. If you get taxed on vesting and it loses value when you exercise or liquidate you do get to take a capital gains loss, but you're likely to be doing that when you're jobless (due to business cycles and/or personal circumstances) so you're in a lower tax bracket anyways.

loeg4• 9 years ago

Also — I don't see any problem with forcing companies to compensate employees in cash instead of employer equity. Especially for publicly traded companies, employees can go ahead, turn around and plow that cash into company stock if they want to. (RSUs are just cash in the form of stock anyway.)

sk5t5• 9 years ago

The issue is that the companies that most depend on options/SARs/etc. to get off the ground do not have the cashflow. Otherwise it would not even be in their interests to grant equity.

sulam17• 9 years ago

RSUs are just cash in the form of stock anyway.

That’s an interesting point. They are and they aren’t. Cash as in actual dolla dolla bills they are not. Cash in terms of GAAP liabilities they are. But “stock-based compensation” is generally the largest part of what public tech companies exclude when they report non-GAAP earnings. And the lion’s share of those will be RSUs.

Why do companies think this is a reasonable way to report? (Other than simply trying to look better for non-experts who don’t know how this stuff works.) The most obvious reason from my perspective is that this is a variable cost that is already baked into the model. The variable part is obvious — if I make a promise to give you 300 shares the value side is going to change over time. If our earnings are crappy and everyone sells the stock (to who?!) then the value of your compensation has just dropped. The cost side is also weird — these shares aren’t bought on the open market at time of vest, they are in employee pools that are set aside ahead of time (in fact my understanding is that the usual terms of an RSU require the stock to be set aside at time of grant). So theoretically they should cost whatever the fair market value is at the time the pool was created. Either way they aren’t cash that left the company’s bank account and went to the employee, like regular compensation.

Accounting is hard!

8ytecoder• 9 years ago

I don't like the government literally making the choice for everyone. It's an incentive structure. It's like taxing a promise note to me that I'll be paid $x dollars in $y years. Options is an incentive which says I can't pay you as well as I'd like but instead I'll share the upside with you. Investors who put in cash are not taxed for the shares they receive. Options should be viewed similarly. It's like sweat-equity in a sense.

zwily• 9 years ago

Thanks for this. I suspect that for most of the situations where people were (mistakenly) freaking out about their ISOs being taxed on vest, they will actually be much better off given the removal of AMT in the bill.

robbomacrae• 9 years ago

AMT started off with reasonable intentions but 47 years later it ended up effecting way more people than intended due to inflation. I feel like the $100k limit will end up doing the same.

tomc1985• 9 years ago

How does it apply to options already vested?

econner• 9 years ago

The problem though is that if you have ISOs they usually have to be exercised within 90 days of departure from a company.

Some companies are extending that deadline to 7 years, but the IRS disqualifies ISOs 90 days after departure so they have to convert to NSOs.

So this would prevent companies from providing an option extension.

hkmurakami2• 9 years ago

I thought about this, and if the taxation trigger is "tax upon vesting", and the vesting is done when the options are ISOs, I would think that it is possible that this legislation is worded in a way so that an ISO -> NQO conversion does not trigger a tax event.

KerrickStaley• 9 years ago

Can you link to the Fenwick analysis that this is based on?

godzillabrennus• 9 years ago

As a consultant who gives price breaks to early stage startups by taking options on a NQSO agreement this is often the only way to avoid getting taxed. This will suck.

ktamura• 9 years ago

Wasn't part of the original tax reform to repeal AMT? Was that lost in the Congressional aisle?

kelnos18• 9 years ago

A potential AMT repeal is orthogonal to this change.

adamw2k• 9 years ago

Just used ResistBot.io (full disclosure, a friend's business) to message my representatives about this.

May not be as effective as calling - but certainly quick/easy.

skywhopper• 9 years ago

I'm a little confused about the mechanism here because the author doesn't explain what's going on or how, or cite any sources. I thought RSUs were already taxable immediately upon vesting. But admittedly I'm not deep into Valley compensation culture. What's changing here?

mmanfrin3• 9 years ago

I remember reading about a nightmare scenario of earlier Uber employees having to give up hundreds of thousands (or possibly millions) of dollars because of how their options were taxed. It has since changed, I believe, but it used to be that:

Upon leaving the company, they would have 90 days to exercise options. If they'd been there for a couple years during the fast growth phase, it's possible they had (e.g.) $500k in options with a strike price at $10k. Uber prohibited secondary market sales, so if you exercised your options, you had to hold on to them until IPO. However, you;d have to pay taxes on the gains on those vested options despite being unable to sell them. Suddenly you were on the hook for $171,500 in taxes ($490k * 35%) plus the $10k to vest as you quit your job -- or else lose out on $318,500 in value on those options. It led to a real golden-handcuffs situation where engineers couldn't really leave without walking away from fortunes.

chimeracoder7• 9 years ago

Upon leaving the company, they would have 90 days to exercise options. If they'd been there for a couple years during the fast growth phase, it's possible they had (e.g.) $500k in options with a strike price at $10k. Uber prohibited secondary market sales, so if you exercised your options, you had to hold on to them until IPO. However, you;d have to pay taxes on the gains on those vested options despite being unable to sell them

Unfortunately, this applies to every successful startup that issues options (instead of RSUs). It's not just Uber.

mmanfrin3• 9 years ago

The difference is that in most situations you can sell vested options on a secondary market, Uber made it a contractual requirement on vesting that they could not be sold on any secondary market (they could only be sold back to Uber for the strike price).

teej• 9 years ago

It’s worth noting that there are companies who will front you the cash to buy your options and cover tax, in return for a cut of the proceeds. People in this situation have options.

mmanfrin3• 9 years ago

I read about these only in response to the situation a lot of engineers were in at Uber -- was this a thing prior?

kevinburke• 9 years ago

A friendly reminder that it's VC's like Fred Wilson who insist on provisions in option grants that require exercise within 90 days of leaving a company.

chimeracoder7• 9 years ago

A friendly reminder that it's VC's like Fred Wilson who insist on provisions in option grants that require exercise within 90 days of leaving a company.

Well, except that the IRS also has a say in this as well. The IRS won't let companies issue ISOs with no expiration date like that; if the company tries, they'll be treated as NSOs for tax reasons, which defeats the whole point.

There was actually a bill last year that would have fixed this specific situation (taxation of ISOs for startup employees in a way that doesn't expire 3 months after termination), but the Senate Democrats blocked it, because they branded it as a "tax cut for the wealthy".

kelnos18• 9 years ago

if the company tries, they'll be treated as NSOs for tax reasons, which defeats the whole point.

How does that defeat the whole point? The entire point of ISOs is that you can exercise without being taxed immediately. After leaving a company, I would much rather have NSOs that I can hold onto, unexercised, until after a liquidity event when the alternative is having nothing.

(I mean, really, though, overall the need for ISOs is ridiculous: the US is insane for taxing unrealized gains in the first place.)

rothbardrand• 9 years ago

Startup Options are already broken-- no liquidity, terrible employee hostile terms (eg: 1 year cliff, losing 90 days after leaving unless you come up with $xx,xxx to exercise options for a stock that won'e be liquid for 5 or more years, etc.) and on top of that the distribution is usually highly weighted towards MBAs to the detriment of the engineers who actually build the product.

So a new model has emerged: cryptocurrency tokens. While ICOs are often scammy, for startups whose business model fits in the form of a currency, this is a better way to reward employees. Liquidity and actual ownership rights... and "vesting" is easy-- just issue them a fixed number per month.

acjohnson552• 9 years ago

Idea: the tax code should simply tax startup equity as normal income, at the time of sale, as much as possible. Tax the difference between value at grant time and value at the time of liquidity as ordinary income. Then tax the difference between that price and actual sale price as capital gains, to avoid penalizing employees from holding liquid stock.

Equity in a startup is effectively deferred cash compensation, in practice. It would be good to eliminate the complexities of option valuation, exercise concerns, and taxation issues from the list of worries of regular employees.

uiri2• 9 years ago

When does the clock for long-term capital gains start?

Better solution: the US tax code should eliminate the short-term/long-term capital gains distinction and just copy the model used in Canada (and elsewhere, I'm sure): capital gains are taxed as ordinary income at a rate of 50¢ on the dollar. So $2 capital gain is equivalent to $1 of ordinary income. The usual rules apply for day traders and such where their "capital gains" are active rather than passive income. The rate doesn't have to be 50 cents - it can be 40 or 60.

acjohnson552• 9 years ago

I'd start the clock either at grant time or vest time. After all, that part of your comp is locked up and you're investing your sweat equity in the company.

SeoxyS• 9 years ago

There are various ways of getting around this tax even if the plan passes:

- Provide compensation through LLC membership units which vest but have no value at the time of grant. - Allow early exercise of options when the spread is zero.

Buge7• 9 years ago

Aren't RSUs already taxed upon vesting? How does this change anything for RSUs?

tanilama• 9 years ago

My reading is, this change won't affect RSUs those can be traded in public market. It will, however, have huge impact on paper money, because you are taxed in advance, and the return might be zero.

Buge7• 9 years ago

But my understanding is that RSUs are always taxed in advance (at vest time). So there's no change in behavior whatsoever with regard to RSUs.

xchaotic• 9 years ago

Fortunately I am tax resident in a country where I will pay taxes on my stock (options) no sooner (actually up to a year later) than when I make money off them with a simple CGT tax. Taxing options before they are exercised and before people made actual dollars off them is just crazy. Unless you are a founder, stock options is just a nice lottery ticket on top of your salary.

crb002• 9 years ago

This should be dead simple. You put 30% of the options in an IRS account. The IRS either sells them at auction or lets you buy them back at cash value when you exercise the options.

There should be no liquidity crunch.

SZJX• 9 years ago

One thing I don't get though is how eventually it has "profound implications for the competitiveness of the US tech sector". If the employees now wouldn't want to be compensated with options because of the tax, can't they be compensated in some other form, e.g. cash? Eventually isn't it still the company and the employee that negotiate the compensation scheme, and essentially the company's decision how much to pay?

The most obvious thing that I can currently think of is just that maybe the startup just doesn't have that much cash in the initial stage, so raising wages to even higher would just bankrupt it, while options is something that would only cost the company money if ever it actually succeeds, thus it can afford to give options away. If one thinks of it in that way then maybe it would make slightly more sense?

Don’t Tax Options and RSUs Upon Vesting

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