San Francisco Wants to Tax Your Stock Options – All of Them

http://techcrunch.com/2011/02/18/san-francisco-wants-to-tax-your-stock-options-all-of-them/

by emmanuelory • 15 years ago

49 37 15 years ago

jonburs2• 15 years ago

"The tax rate? 1.5%. And remember that neither the federal government, nor California, tax gains on most employee stock options at all."

Absolutely false. When exercised non-qualified stock options (the most common kind) are taxed as income (at the federal level) based on the difference between the strike price and the current fair-market value. This is true even when the options are in a non-public company. Every time I've exercised options I've had to pay tax witholding, and the income and witholding were reported on the relevant W2s.

I don't know how most states treat options; I live in one (WA) that doesn't have an income tax.

pkghost• 15 years ago

The article discusses payroll tax, which employers pay, not income tax, which employees pay.

jonburs2• 15 years ago

Employers pay their part of federal FICA (payroll) taxes when non-quals are exercised. Likewise the person exercising the option must pay Social Security (if they're still below the limit) and Medicare taxes.

dedward2• 15 years ago

This is where it gets confusing in Canada, and people get bitten. It DOES work this way in Canada, - when you exercise an employee stock option and convert it to stock, you have an immediate tax obligation based on the difference between your option value and the current market value (specified somehow, I forget). That is considered income, and you are liable for it. If it's going to be considered income, then the employer SHOULD pay the witholding tax just as with regular income, because we're taxed as if it's regular income. I wish employers had done this - mine chose not to (they weren't required to) - and the burden was on me to know that it would be considered income nad I had to pay it. (So yes, that means when I exercised it I sold it all at the same moment, put half away in savings for tax time, and did whatever with the rest.)

fleitz2• 15 years ago

I'm sure there are plenty of other cities who would welcome those jobs. After all part of social responsibility is to look after the needy. San Fransisco and the parasites that feed off the income tax of productive individuals should start considering the high tech job needs of other cities, and other areas with low tax rates.

schwabacher3• 15 years ago

I find this offensive.. I don't live in San Francisco and I can't speak to the specific situation there, but people are not parasites.

And if you are categorizing things into 'productive' and 'non productive', what kind of net benefit to society do you think Zynga produces?

RickHull• 15 years ago

> what kind of net benefit to society do you think Zynga produces?

Zynga produces entertainment.

amh• 15 years ago

"Parasite" may be an unkind word for them, but there are certainly people who produce nothing but expect to be kept in a high standard of living at the expense of those who are productive. This arrangement is not sustainable, despite people thinking that California somehow has a monopoly on tech startups.

fleitz2• 15 years ago

I find parasites offensive as well. Many definitions of parasite specifically cite people as the object being described.

http://dictionary.reference.com/browse/parasite

a person who receives support, advantage, or the like, from another or others without giving any useful or proper return, as one who lives on the hospitality of others.

(in ancient Greece) a person who received free meals in return for amusing or impudent conversation, flattering remarks, etc.

Perhaps you are right as the definition of parasite in regards to people generally indicates living off others by their consent. Rather than living off others by threat or use of force.

anonymous246• 15 years ago

This is the sort of law that I thought only existed in sclerotic zero-sum societies: stupid laws that exist to be selectively applied to harass people. Either repeal it or enforce it. Reminds me of the USSR.

Note, just like this "socialist" law, similar "conservative" laws abound. I dislike them too.

wladimir• 15 years ago

Indeed, authoritarian regimes like arbitrary laws that they can enforce selectively. As long as people fly under the radar, the laws won't be enforced. This makes sure that there will be no protests, because "who cares about laws that aren't enforced anyway?".

On the other hand, police officers (and higher authorities) can use these to lock up people that they don't like, or didn't pay their bribes. It will also mark the accused a social stigma, even though everyone and their brother violates that law, but people arrested for it are "criminals": Very effective in locking someone out of positions of power.

This can concern copyright laws, traffic laws, tax laws, laws with respect to sexual conduct, and so on... they've all been used in this way.

gojomo3• 15 years ago

I started to write about how Lacy's scenario, whereby Twitter (or its employees) could somehow wind up owing $75MM on $5B in valuation-appreciation, is mightily confused. 'Payroll expenses', after all, are counted in the year equity/options are granted, based on the value/discount at that time. That's reasonably like the way other compensation can be valued. After that point, the interest is transferred to the employee, who later will pay capital gains income taxes, when those gains are recognized (or in some AMT scenarios).

It would be unprecedented, as far as I know, for a company to be liable for taxes on the employee's on-paper-only gains, occurring some arbitrary time later at option-exercise.

And yet: that seems to be what Section 902.1(b) says.

The company is on the hook for payroll taxes on the employee's share appreciation, at the moment of option-exercise. Even if the shares are not even sold for any recognized capital gain. Even if the person is no longer a company employee or resident of San Francisco. Even though the company may have already paid taxes on the then-current grant-value in an earlier year.

I not a tax lawyer but on the surface, this seems insane.

cosmicray• 15 years ago

> It would be unprecedented, as far as I know, for a company to be liable for taxes on the employee's on-paper-only gains, occurring some arbitrary time later at option-exercise.

The questions is ... would the same taxation be applicable in the reverse direction ? Say SF taxed you on big paper gains last year, your startup crashed and burned this year. Can you get a big refund ?

If not, then it would suggest a new avenue for arbitrage: trading stock in dead startups merely to offset gains in still functioning entities.

gojomo3• 15 years ago

As this provision only triggers on exercise, not sale, there seems no way for an ultimate loss to balance out for the company. And since an employee would never exercise an underwater option, there's never a 'negative' payroll expense flowing to the company.

Intentionally overpaying for dead/dying/underwater company options/equity, to create offsetting losses, would save less in gains taxes than the new losses taken on. And, there's no indication a company could deduct investment losses elsewhere against this particular purported 'payroll expense'.

gojomo3• 15 years ago

Having researched Non-Qualified Stock Options (NQSOs) a bit more since writing the above, I've learned that for NQSOs, companies are expected to do tax withholding at the time of option exercise, even collecting money (beyond the exercise price) from the exerciser as necessary. This is in expectation of the exerciser's ordinary-income liability for the spread-at-exercise.

That's somewhat like the reasoning of the SF payroll law – though the tax/withholding is from the funds of, and for the liability of, the (possibly-former) employee, rather than the company itself. Still, the SF law is more analogous to current treatment of NQSOs than I'd realized, using the same spread that generates employee ordinary income tax as the basis for the company payroll tax.

So not quite as unprecedented and insane as I'd thought, though still a mess for startups compared to less-taxing jurisdictions.

tungwaiyip• 15 years ago

Yes, every time I exercise NQSO, a paystub is sent to me and tax is withheld. I also get a paystub when exercising ISO, although no tax is withheld. It is actually more chore for me because I need to keep track of the gain and send estimated tax (I only do same day sale, the only sane option in my opinion). The article is very misleading to imply stock option is tax free. Techcrunch never grant her any stock option I figure.

ChuckMcM• 15 years ago

Its a crazy idea, and I agree with the author that implementing it would be suicide for San Francisco. That being said, the existing system of 'employee stock purchase programs' or ESPPs where employees are required to tell the company when they sell them (even if they are no longer with the company) if they hold them for less than 2 years, gives us a hint of how San Francisco might try to implement this.

Company X issues a stock option and records the grant, employee exercises the option and Company X is required to pay 1.5% of the gain defined as the difference between the exercise price and the fair market price at the time of exercising) as tax when its exercised. This 'paper' gain is subject to the same taxes it would seem as AMT which has a similar "your liable for the tax even if you didn't get the gain" pain for tech employees.

Restricted stock would no doubt be taxed at issue time, I would be surprised if it wasn't already but I'm not an accountant.

joelmichael• 15 years ago

I would probably pay a bit more than 1.5% to stay in San Francisco. That amount isn't worth it to give up on your metropolitan lifestyle and appeal to employees.

e40• 15 years ago

So you think the $75M out of the $100M raised is a fair chunk to give to SF?

viggity3• 15 years ago

There should be some sort of state law that preempts municipalities from pulling this bullshit. In SF, who gets to make up these municipal tax codes? The city council? How many people need to make up their mind one way or the other to levy what could be a gigantic tax? 10?

Letting such a small group of people tax have such a gigantic amount of power is dangerous.

viggity3• 15 years ago

For a city of 815K, they have 11 people on their board of supervisors (http://www.sfbos.org/). Does that mean they only need 6 of them to create new taxes?

rdouble3• 15 years ago

No, the residents of San Francisco vote on the taxes.

rdouble3• 15 years ago

There should be some sort of state law that preempts municipalities from pulling this bullshit

Article 13c of the California state constitution.

dedward2• 15 years ago

in Canada, Employee stock options, when exercised, are considered income for that year, and are supposed to be reported by your employer as such, and are taxed as such.

Note this isn't a capital gains tax - and the bad part is there isn't necessarily any income - the value you are taxed t is the fair market value or closing market value, I forget, but it's a simple calculation, based on the difference between the value of the strike price on your options compared to the market. So if you have 10,000 shares at $10, and the market is at $10 or less, and you were vested, you could exercise all those shares, converting them to stock, and there would be no additional income tax. If the stock is now at $20, the tax man would view your conversion of those options into stock as a straighht up $20,000 gain from employment. Generally the move in this situation is to have your broker validate the paperwork with the company, and then ONLY exercise stock at the same moment you are ready to sell it - the broker will handle the whole transaction for you, even short the stock and then use yours to make up for it, whatever. This minimizes your exposure.

Employee Stock Options by thesmselves (in Canada) carry no liability. You can ignore them if you like. You also have the option of, with some paperwork, delaying that tax burden until you actually SELL the stock. IF you did that, you'd still have the same $20k added to your income in the year you sold (you deferred, right?). You still pay capital gains on the difference between the market price on the day you bought (not the strike price on the options, which was what you actually paid) and the selling price - but that's taxed as capital gains. This situation can protect you if you plan to never sell or the company goes bankrupt, if you keep your paperwork and ducks in a row - though there is another hitch if you plan to work and live outside the country (become non-resident for tax purposes) - in this case all kinds of tax obligations come smacking down on you as you are leaving hte jurisdiction. (THe upside, of course, is canadians are only taxed based on residency, not citizenship - so if we live and work abroad for real, not just a short job, but actually leave and don't have any fixed plans to come back, we don't pay or even report income to teh tax authorities in canada)

Disclaimer: My knowledge is a decade old - I suspect some of this may have changed. There was quite a bit of uproar, not about the tax itself, but the specifics that it was immediately considered employment income and that you had an immediate tax obligation. I think something* has changed, not sure what.

grimlck• 15 years ago

I respect you for acknowledging that your information is out of date. As far as how it works today...

In Canada, the gain from stock options is subject to just a 50% income inclusion. So, in your example, if you get a $20000 gain from the stock options, you would only be increasing your taxable income by $10000. In other words, if your marginal tax rate is 36%, the effective tax rate of the option gain is 18%. This is the same income inclusion rate as a capital gain, but it is not considered to be a taxable gain, so you cannot use it to offset capital losses.

The deferral ability you mentioned (delaying tax until you sold the stock) was eliminated in the 2010 Canadian Federal budget. (Relief was also made available for people who used this deferral option in the past, and have had a stock price decline since the deferral)

Disclaimer: I am not an accountant.

patrickgzill2• 15 years ago

American Taxation 101: If you have money or might make some in the future, they want some of it.

haribilalic• 15 years ago

I believe this is the basic principle of taxation, yes.

patrickgzill2• 15 years ago

Actually it isn't - my joke-y comment was to get people to think ... Thomas Jefferson and many of the other Founding Fathers wrote extensively on the subject; as did many others who were not American...including Bastiat, Gesell, etc.

burgerbrain• 15 years ago

Don't forget to mention "take it by force".

EGreg• 15 years ago

If they do it, the situation will be simple:

1) San Francisco enforces taxes

2) San Francisco gets a lot of bad press.

3) Companies start moving to other cities.

4) San Francisco has less startups in the future.

Look at Texas and the taxes they just imposed on Amazon. Did it help them?

johnolagues• 15 years ago

Any creative holder of employee stock options can change their gains into tax free income and not worry about city, state or Fed tax..

John Olagues olagues@gmail.com

San Francisco Wants to Tax Your Stock Options – All of Them

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