Taxes for employee stock purchase in a startup - Advice?

https://news.ycombinator.com/item?id=623710

by joshhart • 17 years ago

13 21 17 years ago

news.ycombinator.com

Hi all,

I'm about to join a startup as the first employee (besides the founder). As part of my package I will get equity. Additionally, we've talked about establishing a policy to transfer salary to equity each month.

I was wondering what the tax laws would be on this. If, for instance, I have a monthly income of $5000 and want to convert $2000 into equity, will I have to pay taxes for $5000 or $3000 of income?

What else should I know? From what I've heard, for this to even be possible we'd have to have an external valuation of the company's worth. Any good links or advice would be greatly appreciated.

pj• 17 years ago

http://turbotax.intuit.com/tax-tools/tax-tips/investments-an...

joshhart4• 17 years ago

I've looked at some stuff, but I don't know if there's any difference for a startup. At a big company there is a specified market price - at a startup without VC there isn't.

adam78• 17 years ago

What percentage of ownership are you looking at as employee #1? What is the industry range for this? Does it vary by how much capital and effort are already invested by founders?

jojoleflaire• 17 years ago

Make sure you learn about the rules around the 83(b) election for your stock.

gojomo• 17 years ago

It's a little odd for a tiny private tech startup to be talking about monthly stock purchases rather than a larger upfront grant (of options or stock) that vests over time. The latter seems much more common.

You owe tax on income when it is received -- whether that income is cash or stock. So in your 'for instance', you'd owe on $5K each month. It's as if they paid you $5K cash, on which you owe taxes, and then you decided to buy $2K of stock.

In many cases, you would rather pay for your full grant at the earliest possible date, before your own sweat equity starts making the stock more expensive. The company protects itself by having the stock subject to vesting if you leave early -- but then you should make absolutely sure to do a prompt "83(b) election" so that you don't owe taxes at each vesting increment.

A good startup lawyer could be telling the founder and you all this, and more. If the plan is for this to grow big, and there will be other employees on stock plans, doing it right is worth the cost.

aheilbut• 17 years ago

You should work with a lawyer to do it right.

(Disclaimer: I'm not a lawyer, but just went through this process...) If the company has no established value, then when it is incorporated the common shares are assigned an arbitrary, very small par value (like 0.0001 cents each).

The company then sells those shares to the founders. So if the company issued 5M shares, and you were going to get 20%, you'd write a cheque to buy 1M of those shares from the company for $100, and that's exactly what they're worth for tax purposes. If this is restricted stock (ie. subject to vesting) then you need to make an 83(b) election within 30 days of acquiring the stock.

DenisM• 17 years ago

Actually, no. You should work with accountant, not a lawyer. By law the lawyer can not give you a tax advice (it's possible in theory but not in practice) and worrse yet, he will likely not know something important.

Obviously if your lawyer is also an accountant you are covered, but this is very rare.

joshhart4• 17 years ago

To address a previous comment made, I will be getting some upfront equity. This is more of an "incentive to reinvest in the company" kind of deal.

Referring back to my example - say I'm usually paid 5k/month but I decide I only need 3k so I ask for 3k and X number of shares. Those shares are assigned .0001 cents since the company has no established value so I now have $3020 in income. Shouldn't I just have to declare $3020 worth of income and the shares are now subject to capital gains?

skmurphy• 17 years ago

If you are paid in stock it's still taxable at the value assigned.In your example a $3K salary and $2K of stock would be taxed at $5K. You are probably better off paying for restricted stock at a very low price that reflects the current state of the startup. In other words negotiate for your % of ownership, pay for it now at "today's price" for the company (and execute the 83(b)), and have your stock subject to buyback restrictions that are on a vesting schedule (such that your true ownership of that % may take three to five years).

See http://www.startupcompanylawyer.com/2008/02/15/what-is-an-83...

dennykmiu5• 17 years ago

I think everyone is giving you really good advise here so I am going to take a different tact which is to look at this from the owner's perspective (i.e., the founder).

My guess is that he believes that he/she has invested quite a bit already and that this is his/her company and not yours. He needs you as an employee and he is treating you as such.

But he is not willing to pay you market value so he is deducting $2K from your pay in exchange for a small piece of the company at an inflated price that at the moment only he can justify.

What makes this one a brain-dead offer is that he is asking you to pay tax on your monthly generous gift.

tptacek3• 17 years ago

I agree with your skepticism about the deal, but not because of taxes. Handling the taxes in a situation like this is a pain in the ass.

The odds of any startup succeeding in any business climate (let alone ours) is low. As employee #1 in the company, you'd want that $2k to be getting a founder's multiple. I don't know what that number is, but my mind jumps to 5-10x. So each time you're getting $2k worth of stock, you want it backed with a story that in 2 years makes you $10-$20k.

The question in this post doesn't contain any numbers (revenue, projections, go-to-market, funding plans), which makes me think that conversation hasn't happened yet with the founder. So what I think is, taking this deal is basically shoveling $2k/mo into a black hole.

I've been in this exact situation twice. I accepted the deal both times. The first time I came out about $20k behind where I would have been with straight salary. The second time, my "investment" made a little better than 25x, which set me up for my own first startup. So it's not like I think this is a rip-off; I just think you're leaving too much up to chance.

Finally, I don't like how Denny is wording this response. $60k/yr is a healthy pre-revenue startup paycheck. It's not rockstar comp, but it's not a rip-off either. If you're getting solid W2 wages, I think it's hard to say that the business "owes" you anything outside of what you can negotiate.

dennykmiu5• 17 years ago

But he is not getting $60K. He is getting $36K, or $18 an hour if he works just 40 hours a week. I suspect he works at least twice that which basically says that he will be working below minimum wage. My point is that he is being treated as an employee and as an employee, he is being cheated.

crhulls• 17 years ago

The advice people are giving you is way too complex. Here is the simple answer: Don't worry about taxes in this case.

1) An 83b is irrelevant for this problem (you aren't vesting over time, thus there is no chance of a large increase in the share price before you get your grant)

2) You aren't getting $2000 a month in stock. You are getting what he is saying is a fair equivalent of $2000 a month. You might have to report a couple bucks a month in income to the IRS, but it will be negligible because the real value of anything he gives you will be basically zero on paper

3) You pay taxes on the market rate of anything you get..keep that in mind.

4) If you really don't want to worry, don't get a stock or options grant, just "purchase" your shares from the company. At a fraction of a cent each, the shares are essentially free, so just write the guy a check. Since you bought them you won't be taxed until you have a gain.

joshhart4• 17 years ago

OK this makes some sense. As long as there is no valuation, I basically don't have to pay taxes on whatever salary I convert to equity because the current value is nil. Now if/when the equity is actually worth something, I just have to pay capital gains, right?

anamax• 17 years ago

> 1) An 83b is irrelevant for this problem (you aren't vesting over time, thus there is no chance of a large increase in the share price before you get your grant)

How do we know that he is purchasing all his stock up front with no restrictions?

If he is, he can quit now and get a job that pays him market rate while keeping all the stock. Somehow I doubt that that's the case.

If he's purchasing stock each month (or getting the right to keep stock that he's been granted, that is, repurchase rights are expiring), 83(b) is relevant.

Taxes for employee stock purchase in a startup - Advice?

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