The original point of ISOs was to offer to employees the opportunity to take an economic risk with stock options (by exercising and paying for the stock at the bargain price) while avoiding the tax risk (by generally not recognizing ordinary income from that exercise and being taxed only at the time the stock was sold, and then only as a capital gains tax).
AMT has since emerged to devour the value of this benefit. By having to include the value of the spread (difference between exercise price and fair market value of the stock on date of exercise) as AMT income and pay tax on it at 28%-type rates, an employee can incur great tax risk in exercising options - especially for a venture that is in advanced rounds of funding but for which there is still no public market for trading of the shares. Even secondary markets for closely held stock are much restricted given the restrictions on transfer routinely written into the stock option documentation these days.
So why not just pass a law saying that the value of the spread is exempt from AMT? Of course, that would do exactly what is needed.
The problem is that AMT, which began in the late 60s as a "millionaire's tax", has since grown to be an integral part of how the federal government finances its affairs and is thus, in its perverse sort of way, a sacred cow untouchable without seriously disturbing the current political balance that is extant today.
And so this half-measure that helps a bit, not by eliminating the tax risk but only by deferring it and also for only some but not all potentially affected employees.
So, if you incur a several hundred thousand dollar tax hit because you choose to exercise your options under this measure, and then your venture goes bust for some reason, it appears you still will have to pay the tax down the road - thus, tax disasters are still possible with this measure. Of course, in optimum cases (and likely even in most cases), employees can benefit from this measure because they don't have to pay tax up front but only after enough time lapses by which they can realize the economic value of the stock.
This "tax breather" is a positive step and will make this helpful for a great many people. Not a complete answer but perhaps the best the politicians can do in today's political climate. It would be good if it passes.
You can keep deducting that capital loss on the options exercise going forward against future capital gains, and up to $3000 more can be deducted against regular income each year until you balance everything out.
BUT
Since the gain is actually unrealized the best answer is ask your CPA. Really.
Only in years where you have no AMT liability. GL with two earners in California. While you have AMT liability you have to keep endlessly carrying forward your 0% interest loan to the govt.
1- I don't know how exactly AMT liability interacts with the capital loss carry over
2- Almost nobody hits the AMT jackpot year after year.
3- Ask your CPA and California's tax system is one of the worst in the country. They keep milking that SV cash cow year after year, and it is drying up but they don't seem to care :)
A lot of people in California (and NY, NJ, etc) hit AMT every year. Two incomes, with very large deductions for state income tax, mortgage interest, and property taxes paid.
Its usually a bad idea to take stock options instead of a market rate salary because most options are worthless in the long run. Lots of people do it anyway because they have a fantasy about making it big. As it stands now this is a life lesson that people spend some time in their 20s figuring out and probably walk away with nothing but some valuable experience.
Under the current scheme exercising illiquid options is a bad idea most of the time if you can't pay the taxes on it and this is obvious. This change doesn't make it a better idea but it makes it much less obvious that its a bad idea.
That 20 something that would have walked away with nothing will be much more likely to walk away with a 6 or 7 figure tax debt that may cripple him financially for the rest of his life.
This is the current meme on Hacker News, but IMHO the pendulum has swung too far.
You should absolutely be very careful about working for an early-stage startup as an employee and taking options or equity in lieu of part of your salary. You should feel that you trust the founders. You should insist that they've figured out a.) who their customers are b.) why they want the product and c.) how to make money, and have some concrete evidence that the customers do in fact want the product. You should ask about the cap table, and liquidation preferences, and anticipated future dilution, and know what percentage of the company you'll own and how much you'll make under a variety of exit scenarios.
But if the numbers look good and you have solid evidence that people want the company's product, oftentimes taking more equity is the right move. Equity aligns your incentives with the company and ensures that if it does well, you do well. Under capitalism, taking cash is a loser's bargain, not in the sense that you always make less money (you often make more), but in the sense that cash dominates equity only if you've picked a losing organization. To the extent that most organizations lose, this can be rational, but to the extent that you're an independent economic actor trying to maximize your returns, it's often worth putting in the research to try and maximize your chance of picking a winner, particularly given the other career benefits of having a hot startup on your resume.
The optimal long term strategy for managing a portfolio of independent investments is to always pick a mix that maximizes the expected value of the log of your net worth. This leads to a more conservative investment strategy than the naive "maximize your expected value", and explains such things as why money-losing investments into buying insurance can be a really good idea.
In general this is probably not a bad life strategy.
Let's use the back of the envelope that of VC backed companies, 10% are great successes, 60% die, and 30% will last a good amount of time but don't recoup the investment. The average employee in a successful startup will get a nice payday, but not exactly a life changing amount.
This is doubly true for people capable of being software developers. Your expected income from work is already sufficiently high that a million dollar payday does not change the log of your net worth by that much. Having worked in a hot startup is good for your salary, but usually not by a factor of 2 let alone enough to really change the log of your net worth.
The end result is that it is economically irrational to give up, say, 5% of your salary in return for a chance at hundreds of thousands if the startup sells for hundred's of millions.
Now there are lots and lots of reasons to be an employee at a startup. If you do, there are lots and lots of reasons to pick one that you think has a good shot. But the hope of becoming rich off of options is only one of them if you derive great entertainment value from it.
I get that your utility function from money is non-linear, but I would expect a more accurate model to be a step-function, with large steps at "out of debt", "can tell a bad boss sayonara", "can buy a house", "can pay for kids' college eduaction", and "never have to work again". Equity payouts from a typical startup exit often line up nicely with the middle three, and if you hit the Google/Facebook jackpot, sometimes the last.
Log is often used because it makes linear proportional returns. It makes the most sense when gains are considered derived from the principal, ie proportional returns from capital. See an example below.
As others have mentioned, maximizing log is equivalent to maximizing the underlying.
But when considering returns on accruing capital, a 20% loss is much worse than a 20% gain is good, and similarly a 100% gain is much less good than a 100% loss is bad. This is correctly captured by taking the log. In the case where money is simply accrued from some external source, and their is no proportional return, log isn't necessary.
Independent investment opportunities generally have the effect of multiplying your value by a random amount over a specified interval. When you take logs, you are adding a random amount instead. From the strong law of large numbers, after enough intervals, it is statistically certain that the sum of the logs of those random numbers numbers will converge on the number of intervals times the expected value of the log of your investment strategy.
Therefore maximizing the expected value of the log maximizes the long term rate of return that you (with 100% probability) will observe.
Well, he's suggesting maximizing the expected value, which is a little different. For example, a situation where you have a 10% chance of making $10M and a 90% chance of making zero has an expected value of $1M, but its expected value in log10 space is 0.7 = only about $5, while a 100% chance of making $100K has an expected value of $100K, but in log10 space = 5 = $100K.
I still quibble about the use of log for this purpose (and even if you do, what base?), but I see his point. A non-linear utility function penalizes low-chance but high-value outcomes.
The most general (correct) form of this statement is "use the expectimax algorithm". Yeah, it's a bit weird that he's prescribing log as the mapping from dollars to utility.
If log is the correct mapping for you, it actually doesn't matter what base you use. It just comes out as a constant factor on the expected utility.
How does the expected value of the log of your net worth deal with the possibility of a negative net worth? Any finite probability of zero net worth will weigh infinitely in the log domain, right?
The pendulum hasn't swung far enough, because the predominant meme on HN (because it benefits the YC model directly!) is that investors and founders are kinda sorta the same class, and early employees and everyone else can eat shit and die ("Graduate to better things").
These same folks will balk at a few points of stock, will backload options so folks're basically handcuffed to a desk for a few years until vested, and will buy into the rubbish pushed by Scott Kupor that explicitly views early employees as obstacles to be stripped of their equity to fuel later growth ("Are there any other management practices where one would optimize for former employees at the expense of current employees?").
This exploitation is slowly getting the results it deserves.
> Equity aligns your incentives with the company and ensures that if it does well, you do well.
There is not a strong correlation between how well the company does and how well you personally do. You can be relieved of your options through contractual shenanigans, you can be put (even with this bill) in a place where you can't afford to exercise them within their window, you can be burned out or injured to the point where you have to leave and then the company reaps the benefits of your work and you don't.
Moreover, your incentives are never aligned with the company, because companies are utter sociopaths and fear no backlash from screwing you over if it makes economic sense. You will almost never legally be in a strong enough position to fight the company with its resources if you find yourself in a bad place--unless the company has grossly fucked up. There can be no meaningful alignment of incentives under such an environment.
> Under capitalism, taking cash is a loser's bargain, not in the sense that you always make less money (you often make more), but in the sense that cash dominates equity only if you've picked a losing organization.
This is a gross over-simplification. If you are unable to maintain a large enough equity chunk, you may not make more than a salary would've provided. If the company stock tanks, you may not make more than a salary would've provided. The idea of "a losing organization" just isn't very useful here, because a lot of organizations "lose" for any number of reasons--unless the definition here is being picked as "an organization whose equity is worth more than salary", which is a cop-out.
I'd add that it's entirely optional for anyone to take any job and this includes a start-up. If you want a regular job with regular hours with regular stress levels, then please, don't even bother looking at entrepreneurial employment opportunities.
But if you do, you might as well go all in and mix your salary with options, work your ass off for a couple of years, learn as much as you can, build a network, and then if it pays off, great. If it doesn't, don't have regrets that you "lost" a larger salary during that time. Be thankful for the opportunity.
Obviously some situations can unravel in a highly negative manner (the partners sell, but disavow all options, the partners fire you before paying out options to other employees, etc), but those are just normal risks in start-up land. Buyer beware.
But if I were actually in my twenties right now, I would bust my ass at a start-up, have a blast, kick-ass writing code, learn a shit ton of technology, and be grateful for the opportunity.
I think this is kind of an unrealistic view of startups that's been championed a lot. I'll concede that I only have 4 data points (4 jobs), but when I worked at a startup, my responsibilities were much more limited and defined than where I am now (200+ people, 80 IT). A lot of that was due to cycling through management styles like scrum and kanban, but this is to be expected at startups that haven't figured out what works for them yet and want to copy everyone else. I also think I've learned a lot more at my current company than at my startup where I was surrounded by "fake it to you make it" people. I value the network I've built up there more too. Before you jump into that circus, look at the middle. It's not startup or 5000 person company. There are plenty of established companies in the 50 - 300 person range that are nice places to work and to learn and pay market rates. I was able to jump into trading from there and get 2-3x market rates
You're forgetting that options/equity/shares/whatever have many conditions AND on top of that there are complex schemes which can render them nil. The stockholders/VC know that and they are very good on the legal stuff.
A salary comes with no trap. You can ensure every month that you got the money.
No, I remember all those. You should know what they are and how they may be used against you, and you also should have a fairly good idea if your founders are likely to do that. Just because some people are untrustworthy sociopaths does not mean all people are.
If your boss wants to fuck you over, there are plenty of ways for them to do so, in career-ruining ways, even at a salaried job.
> You should know what they are and how they may be used against you, and you also should have a fairly good idea if your founders are likely to do that.
That's what everyone is saying: knowing all of that stuff, the reasonable thing is to take salary. You're just choosing to ignore that that line of reasoning makes sense because you'd prefer yours.
Have you ever been on either side of this sort of thing when it's gone down, or are you just regurgitating the party line?
I've worked as an employee for 2 startups, both of which failed. I had options for one and took all-cash compensation for the other. I've also founded two, one of which outright failed and the other of which is still in search mode. And I worked at a big company, where roughly 50% of my rather generous compensation was in equity.
I'm arguing that the reasonable thing to take is not salary, the reasonable thing to do is get a different job. It's not worth fighting over the scraps of a company that's going nowhere. Find someplace where the pie is expanding and then you avoid all the fights and backstabbing over who gets the pie. If you can't find such a place, create one. (That's why I'm founding a startup now; I'm not averse to working as an employee for someone else as long as they have their shit together, but I see relatively few such companies that I'd like to work for right now.)
Honest question: do you think you could have chosen that companies were not "losing bargains" seven years ago? How many companies are there today that you think would grant you significant equity and also will reach liquidity in the next seven years? How would this change if you were an early twenty-something with few connections and little savings?
Off the top of my head I can only think of a handful of companies today, and even with those I'm not sure I would take a six-figure gamble with most of them. If I were a decade or two older things would be significantly different.
Obviously I didn't choose right - the first two startups I worked for both failed. And then I was like "Never again" - I was the voice on HN saying that early employees get screwed, c. 2008 - and that blanket prohibition made me miss out on being employee #2 at DropBox (along with 10 or so other startups that went nowhere).
More to the point, though - I don't think that the point of a career should be to minimize risk. Or rather, you certainly can choose to minimize apparent risk - but that usually means that whoever owns the least risky option (probably Google, today) will use that as a lever to get you to accept whatever terms they give you, which is its own form of risk. Ironically, very few of the senior software engineers I knew at Google actually had "Work at Google" as a career goal - most of them were ex-startup-founders, or Ph.D dropouts, or had toured in a punk rock band decided they want an office job, or washed out of law school and figured programming looked more interesting. You gain a lot of confidence by failing at something you thought was important to you, and that helps you focus on the next thing that's important to you.
I think that your goal, when you're a 20-something with few connections and little savings, should be to gain experience as quickly as possible. That's what lets you take prudent risks when you do have the means to do so. If you've never failed at something or gotten screwed over when you're 40, you're probably about to start, and your failures will be much more visible, painful, and harder to recover from than if you fail when you're 22.
> and that blanket prohibition made me miss out on being employee #2 at DropBox (along with 10 or so other startups that went nowhere).
That seems to have worked out ok, though, if you only had a 1/11ish chance of jumping on a startup being the right decision at that time, anyway. It doesn't dissuade me from the "options are most likely worthless, and akin to a lottery" viewpoint.
However...
> I think that your goal, when you're a 20-something with few connections and little savings, should be to gain experience as quickly as possible.
This is good advice, and I'm no longer in the 20-something bucket myself, but the trap I see friends among that group falling into these days is jumping from the "akin to a lottery" thing into a "I'm going to gather as many tickets as possible" job-hop-every-year strategy.
The downside is they aren't gaining much useful experience, and their "connections" are mainly just to an insular group of VC-funded founders and other inexperienced engineers. Being the most experienced engineer (with 2 years of experience before joining) at a company of 20 people with all the other engineers being straight out of school isn't particularly useful experience. You can make it work, but it's much harder - nobody to learn from, no mentor, etc. And if the projects you're working on are just basic social or game apps over and over, your experience isn't very deep.
So if that tight-knit pool dries up... what are you bringing to the table when you're looking for a job at somewhere a bit larger and more stable?
What about the alternative of building up wealth? It's the conservative view, but if you get to 30 or 40 with significant assets, you have a lot more flexibility to explore what you want without worrying about money. With the supply demand curve favoring devs for the time being, why not jump from job to job taking the compensation increase each time? I think my 2-3 year stints will catch up to me at some point, but if I have 1-2m in liquid assets, I think I'll have a much wider set of means than if I had optimized for experience. You'll still fail and learn, but you'll be sitting on cash instead of worthless options
>> If you've never failed at something or gotten screwed over when you're 40, you're probably about to start, and your failures will be much more visible, painful, and harder to recover from than if you fail when you're 22.
Really good advice. Which at 40 I will now ignore ;-)
Exactly--this bill is a pernicious half-measure that only serves to further obfuscate the problem. One can exercise in-the-money but illiquid options without grappling today with the problem of selling them while being anchored to a heavy tax obligation ("seven years is a long time, surely by then there will be a market").
No, you realize ordinary income tax on the spread, which is payable in full in the year realized (or in the year to which it is deferred under this measure) while the loss of the stock value is a capital loss, which can only be offset against other capital gains or deducted at the rate of $3,000 per year. So you could easily have a situation in which you realize tens or hundreds of thousands in ordinary income on which you must pay tax and have only the ability to deduct $3,000/yr against that income, i.e., a tax disaster.
Yes, that is correct and thanks for pointing out that I had not included the "/yr" after the $3K. I have now corrected it in the comment above. So, yes, you keep carrying any capital loss of this type forward until you get to deduct the whole thing over time, either at $3k/yr or as an offset against future capital gains.
Citation / reference on most options being worthless? I feel that most companies that make it to that stage pan out beyond being worthless. I must be missing something, since I'm not that familiar with how options in startups work.
A friend of mine got caught that way. He wound up owing more tax than his net worth, even though he'd never had that "income" from the options. He had to make a deal with the IRS, lost everything he had, and had to start over (despite being middle aged).
When a new round is raised, the price paid by the investor gets her a preferred share. How does one compute the FMV of common stock compared to this? Specifically, are there any regulations regarding the max discount that can be applied to the price paid by the last investor to get the FMV of the common stock?
I recently came across a case where the FMV of common stock was only few %ge points less than what the last investor paid. But the investor was rumored in the press to have gotten significant privileges (a ratchet) for that price. So I was surprised that the prices were so close. Does anyone know why that could be so?
The FMV of common stock should be calculated through a 409a valuation, which should take into account the preferences. The company is supposed to do this on a regular basis, and certainly should have a current 409a a the time of an option grant. An individual can't really calculate an FMV on their own (outside of a sale, which unto itself creates an FMV).
If one receives options before they are valuable, then there is a high valuation during which assets are illiquid and one defers taxes, then the value collapses as the company folds, are you still stuck with a huge tax bill? If so nothing has been fixed. There's no point in patting politicians on the back if there is a simple fix and instead they passed a complicated partial fix.
The sad thing is that it could have been relatively easy to address by allowing something like a disqualifying disposition as long as the tax is deferred.
I'll probably take advantage of it to exercise some of my shares, but I will have to stick within the range of where I know I'll be able to pay it off within the next seven years even if I never see value for the stock.
I'm at a startup and haven't exercised for this exact reason I was hoping this was to fix that.
It's unclear to me that if I defer it and the company goes out of business before then, does that mean I pay no taxes?
And if the price goes up do I pay capital gains or income tax on the difference in value between now and what it went up to? What about the difference between now and my excise price.
In my unprofessional opinion you need to know at least two things to get an idea of whether or not you will owe taxes when you exercise: 1) the strike price you pay to exercise your options, 2) the current fair market value (FMV) of the stock
You will only run into this AMT trap if there is a difference between 1 and 2. This could happen if you were granted options a long time ago and your company has since raised new rounds which increased the valuation. This is when the IRS eyes your exercized options as 'income' unlike the normal case with ISOs where the strike price and FMV are pretty close.
Thank you for this clarification. I was wondering how holding these options would screw the average employee, since I didn't think the value was taxable, but the impact on the AMT is the piece I was missing.
I've got to think that once we start making loopholes in the AMT there will be no stopping it, and it'll quickly turn back into the regular tax code.
> Only startups offering stock options to at least 80 percent of their workforce would be eligible for tax deferrals, and a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
I understand the desire to avoid a regressive taxation system, but why is it that every tax rule we create comes with 2x the amount of caveats and rules? Our tax system is becoming a mess.
At this rate soon nobody will be able to file their own taxes without an accountant to sort through the muck. And complicated to systems tend to benefit the wealthy.
> At this rate soon nobody will be able to file their own taxes without an accountant to sort through the muck. And complicated to systems tend to benefit the wealthy.
It also heavily benefits Quicken. Along with HR Block, they heavily lobby against any effort that simplifies the tax code. Capitalism, American-style.
Intuit is a pretty funny company. They try to make TurboTax as simple as possible for the average American (most Americans can fill out a 1040EZ and be done in minutes), but at the same time try to make taxes as complicated as possible so that they can sell services around that. It's both smart and infuriating .
Intuit's position isn't necessarily pro-complexity, they'd actually prefer the tax code simplified somewhat, because they'd need far fewer employees to update the tax code information in the software every year. The lobbying is to keep the IRS from A) releasing free 1040EZ/A software and B) keep the IRS from simplifying even further and just sending you a bill, like HMRC does.
It's somewhat infuriating that the IRS doesn't just send you a bill. It has full data on every form you put into TurboTax. It runs its own calculations independently and checks them against your return. It has full knowledge of the tax code. If you disagree with it, the IRS just tacks on penalties & interest and eventually garnishes your wages. Why not just send a bill?
the US is in a weird position where the federal government actually has very little power. But it has tax power. So they just use taxes as a way to manipulate things in the way they want.
But as far as I understand, the US tax system is also one of the 2-3 most complicated in the world... Being an permanent resident and not being used to this from my home country, Im making a lot of suboptimal financial decisions purely to avoid complicating my taxes... eg: I avoid consulting like plague, even when I have a worthwhile opportunity to do so.
The cost of a CPA is many orders of magnitude less than whatever "suboptimal financial decisions" you are making. Not consulting to make your taxes easier is borderline idiotic at standard 1099 developer rates. Two or three hours in a year pays for the CPA and all the overhead.
I actually don't believe the federal government has very little power. The Supremacy Calause, the Civil War, erosions of the 10th amendment (the US code is intense!), having a court called the "Supreme" court, regulating interstate commerce, adjudicating disputes between states, raising an army, and of course taxing citizens in any state should provide ample support to the federal government's power. And yes, they also control individual states by proxy using fund distributions as a carrot (road standards, national speed limit). They control immigration into the US; no individual state has the power to invite a foreign citizen into a US state.
I wouldn't avoid opportunities because of the complexity of the tax system. Ask around for good accountants, they won't be as expensive as you think. Consider paying an accountant as a necessary cost of doing business.
Odd because the complications create the opportunities
I pursue certain characterizations of income
Ie. If I know my employer withheld too much social security tax then I'll consult because no money is withheld and not worry about paying taxes on it because it will balance out
Or I'll pursue a compensation structure that can be characterized as capital gains instead of self employment income
You could find an accountant to do your taxes. It would probably cost much less than you'd make consulting, and sometimes they can find ways to save you more money than you paid.
That's right. I always use an accountant who is a family friend. She charges about $200-$300 but manages to usually get back multiple magnitudes of that back. Plus she's always there to answer any questions about what options I have and what should be my best strategy.
> a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
Where is the line drawn on this? I am a companies highest paid executive... I make a whopping $100k. Some of the others have no pay check at all. Exersizing would net a $40k tax bill for me. 40% of my pre-tax take-home pay. But as the highest paid executive am I exempt from deferring?
Edit: to answer my own questions...
> who has been for any of the 10 preceding taxable years one of the 4 highest compensated officers of such corporation determined with respect to each such taxable year on the basis of the shareholder disclosure rules for compensation under the Securities Exchange Act of 1934
Translation... I guess this doesn't benefit me, then.
Well based on this bill unless they are the CIO or CEO they can defer their taxes. Whereas I can't. Yet I have much less wealth than the other people. So the bill doesn't really help in my case. And being an early stage employee having an executive title is very common.
A complicated tax system is perfectly fine if its control logic is algorithmic and its parameters are easily found by the taxpayer. That's already somewhat true, since tax law is written by lawyers and accounts, who make excellent programmers if given appropriate training. Unfortunately, for me at least, legal English is 1000x harder to parse and understand than any nonesoteric programming language.
> A complicated tax system is perfectly fine if its control logic is algorithmic and its parameters are easily found by the taxpayer.
Expecting a normal human being to navigate anything complex in unreasonable. Complex is a relative term. By definition, if something is complex, it is difficult for an average person to navigate.
I know where you're going with this, if something is consistently coherent we can use computers to manage the task and to some extent, things like Turbo Tax help.
But ... there's no reason we can't have a simple tax system. None at all.
> But ... there's no reason we can't have a simple tax system. None at all.
Most quirks and exceptions in our current system have their own constituencies who are willing to send lobbyists to defend the status quo. Those constituencies represent the thousands of reasons why we can't have a simple system. There is no comparably powerful constituency for making taxes simpler. Most people just don't care that much.
And thus, death by a thousand cuts. If an entity is getting 20k in tax breaks or "handouts" it's in their best interest to defend that. To the taxpayer however, the $1.78 you're paying (or whatever the minuscule number is) to cover that annually is nothing to you, and certainly not worth your time to fight against.
The tax system has always been a mess and there are exceptions and loopholes for everything. I don't disagree that it's bad, but I don't know why you'd expect it to change all of the sudden with these rules.
And those two specific exceptions don't seem particularly bad, IMO.
This is to stop people from gaming the system. For example: a company founder started offering stock options but only to their children. This would allow a parent to pass their company to their children avoiding estate taxes.
I agree that there's too much added complexity in the tax-code but do you really feel that this requirement is that onerous?
The likely motivation being being in line with those around 401k account requirements: if a company uses this, it should be to the benefits of the employees and not just the executive staff.
They should just say, "hey, if you work, you can invest it tax-deductible and tax-deferred".
The current system is, "if you work, then you should be able to participate in your caricatured, mustache-twirling, ultra-rich boss's tax-deferred plan, in accordance with all these rules and exceptions that clumsily try to make him share his bottomless wealth with you."
Except that, if your employer offers a 401k at all, you lose the tax deduction benefits (if income over 70k). And the contribution limits are much lower.
> fixing it without paying the cost at the same time may still be worse.
That's probably true if we're talking about a tax that's more than a rounding error on the total federal budget.
In an ideal world, you'd have a criteria for what makes a tax worth it.
For instance, some criteria might be:
1) Does the tax raise substantial money for the on-going operation of the government or to fund critical programs? (In this case, the answer would be "no" since $100M/yr is a fraction of a fraction of our federal budget.)
2) Does it incentivize a certain type of behavior that society has deemed "good" or penalize a behavior society has deemed "bad"? (In this case, penalizing people for working at a quickly growing but illiquid company doesn't seem like it benefits/hurts society one way or the other.)
3) Can the tax be paid without undue burden to the person paying? (In this case, the burden on gains that the employee doesn't actually have in their bank account could be $100,000+ on gains they don't have yet. I'd call that undue.)
I'm sure we could come up with more criteria too, but at face value, it doesn't seem like this tax has too many good legs to stand on.
> > fixing it without paying the cost at the same time may still be worse.
> That's probably true if we're talking about a tax that's more than a rounding error on the total federal budget.
Its true in any case; the fact that the total cost is very small compared to the budget means that, yes, the magnitude of any net harm from not paying for it is likely to be small (but, it also means that its also extremely easy to pay for.)
Disregard net costs because they are small means that large harms that you would block if they were proposed together become acceptable so long as they are broken up and spread out among separate bills.
If you make a policy of ignoring individual things because the cost in isolation is trivial, the sum of those ends up not being trivial. Or, as is popularly misattributed to (but endorsed by) Senator Everett Dirksen: "A billion here, a billion there, and soon you are talking about real money".
It's quite common to owe taxes today for gains on the value of your stock -- which is an illiquid asset you can't sell. This puts employees in the position of shelling out cash to keep something that rightfully belongs to them, or simply abandoning it (failing to exercise) when they leave the company. This bill would defer taxes on gains up to 7 years, or until the company goes public.
If you are awarded stock options, an you exercise them, you have to file an 83(b) election within 90 days or else you are liable on all paper gains in the value of your stock.
Even if you file an 83b election, you are still liable for paper gains between the value of your options when you were granted them and the value when you exercised.
For example, if you were awarded options with a strike price of $5 and the company raised a new round of funding and the 409A valuation (& strike price of the new options) has risen to $15 per share, the IRS considers that you now owe taxes on $10 of income / share. In other words, it costs you not $5 / share to exercise but ~$8.50 including taxes.
So the tricky part about options is that they require money to exercise, money that you often don't have ready, in order to obtain an asset that is (a) not liquid and (b) may decline in value (c) you often can't sell due to transfer restrictions.
For example: one early engineer at Zenefits had to pay $100,000 in taxes for exercising his stock....and then all the crap hit the fan, and he likely paid more in taxes than his shares will end up being worth. Ouch.
As a result of this problem with options, many startups -- especially later-stage ones like Uber -- choose instead to offer RSUs, which are basically stock grants as opposed to stock options. You don't have to pay any money to "get" them like you do for options.
However, the IRS considers stock grants, unlike options, immediately taxable income. If you get 10,000 RSUs per year, and the stock is valued at $5/share by an auditor, you now have to pay taxes on $50,000 of additional income, for an asset that you likely have no way of selling.
Some startups allow "net" grants -- which basically means they keep ~35% of your stock in lieu of taxes. That solves the liquidity problem, but offering this is completely at the discretion of the startup and some don't, which leaves employees at the mercy of the IRS, again having to pay cash on paper gains of an illiquid asset.
> For example: one early engineer at Zenefits had to pay $100,000 in taxes for exercising his stock....and then all the crap hit the fan, and he likely paid more in taxes than his shares will end up being worth. Ouch.
Would this bill actually help this scenario? I'm unclear if deferring the tax liability just means that you pay the same amount of tax later, or if you can write off capital losses like this at the time your liability is due.
This bill reduces the main reason that employees exercise their options "early" while they're still illiquid.
The employee likely wouldn't have paid that money until there was an actual liquidity event.
"Even if you file an 83b election, you are still liable for paper gains between the value of your options when you were granted them and the value when you exercised."
Wouldn't this be taxed as capital gains though - when exercised?
A typical structure for RSUs (Uber included) is to delay activation until liquidity is possible. Until then, a contractual obligation to deliver the RSUs is what the employee actually possesses (after vest). Employees are free to exercise RSUs and pay the income tax hit, but I can't imagine a scenario when that would be rational. Especially since the company holds vested RSUs for separated employees.
Nobody at Uber is having to sell their Tesla P80 to cover the tax from their newly-vested RSUs after their annual cliff occurs.
I've only ever heard of companies offering to withhold enough shares to cover the tax obligation. Is that what you mean, or do you really mean giving the employee an additional cash bonus to cover the taxes?
They're taxable on delivery. For public companies that's almost always at the same time as vesting, but for private companies that's generally at the time of an exit.
True, but is it the IRS' fault if the corporation refuses to create a market for their shares? If the IRS didn't tax these shares, it would quickly become a tax shelter of epic proportions, no?
No. But it isn't the individual's fault either. And it IS the IRS' fault for taxing an illiquid asset as if it were liquid.
The only way that this sort of makes sense is if you can pay your tax in illiquid assets - e.g. If you can pay your tax with the same shares.
The most logical tax code I know can be summarized as: no basis step-up except on an event when taxes are paid; taxes are paid whenever (and only if) something liquid gets exchanged. Even an exchange of illiquid with illiquid doesn't trigger step up or tax event.
As long as it is illiquid, taxing gains seems about as logical is randomly announcing "everyone should mark their assets now and pay taxes on unrealized gains" (which the IRS actually does if your financial asset is outside the US, but it is still crazy)
I can't upvote this enough. If the IRS is ascribing value X to stock options I can't liquidate, I should be able to pay my tax in the form of those options at whatever value I am being taxed on them.
Of course, the devil's in the details as you probably don't want the government having voting shares in a bunch of private companies either... Maybe they just get a blanket clause to automatically exercise and sell as part of any IPO offering or something?
This could have a double-down effect too as the government owns more illiquid stock and feels firsthand the pain of regulations (SarbOx anyone??) that result in fewer IPOs / longer time horizons to liquidity.
Oh your revenue is going down because you've regulated companies out of the IPO market? Great, looks like time to get off your ass and actually FIX THE PROBLEM. C'mon guys.
That it will become liquid one day. If you get to make all sorts of incredible options deals under the cover of "not in the market" then you can simply make lots of situations like this happen and simply bring them to market when there is no risk involved for you anymore.
> So? Why should taxes be paid unless there are actual gains? What's the problem with waiting until gains are realized to tax them?
Exactly. And what the article or the linked Bill summary fails to make clear (unless I missed it) is whether the tax amount is based on the value of the stock the day the options are exercised, or when the tax is paid. By the time the stock becomes liquid, it might be worth far less than that it was when the options were when the options were exercised. Maybe far less than the actual tax bill. And what happens if the stock's value goes to zero?
I'm with you on this. I don't see why they can't tax this like any other stock trade, where you pay tax on the actual monetary gain, after it has been realized.
A key factor in whether that's truly a tax shelter is control. If your not in a position to make or even influence decisions about liquidity, you're not exactly a voluntary participant.
Would it become a tax shelter, though? You could just tax the difference between what goes in and what goes out on the date that it comes out. If it never comes out, it's worthless and that's the point.
The liquidity of startup shares has gotten better in recent times. I'm an engineer at http://www.equityzen.com, a marketplace for pre-IPO shares, and I believe more shareholders are starting to see that selling before an exit is a viable option for faster liquidity.
We helped lobby and push for this bill and I'm glad to see it making progress in providing better options for startup employees.
The second market is a bandaid. In addition to sub-par prices there's a huge bottleneck in the demand for shares, which is extremely volatile. And if cofounder X decides to offload 10% of his shares it'll wipe out any demand there is.
Equity is awful for a lot of reasons, but I'll never be convinced second-market selling is the panacea.
Most employees get hit by the AMT and the step up in basis when exercising their incentive employee stock options, and from just skimming the bill, I don't see how that is prevented.
If the income is deferred, I would imagine that it wouldn't apply to AMT calculations. It'd be nice for that language to be explicit though.
Regardless, the Obama Administration "strongly opposes" the bill in its current form since it would "increase the Federal deficit by $1 billion over the next 10 years."
The federal budget was $3.8 trillion (with a "t") last year, and the deficit was $438 billion. Increasing the annual deficit by $100 million[1], or 0.02%, seems like a non-issue.
[1] $1 billion over 10 years is $100 million per year.
Agreed — it's a pretty weak reason to "strongly oppose" a bill, which is why I'm wondering how likely it would be for the Administration to change their position. Like, what percentage of the time do they issue a statement in strong opposition but then end up passing the bill anyway?
You should make this a top level comment. The fact that it's opposed by the Whitehouse has got to hugely lessen its chances of becoming law. That's a highly relevant data point.
I was looking for that language as well - I expected to see that "gains" from exercising options do not count towards AMT, and that related taxes are completely deferred until the time when the investment becomes liquid (or 7 years?).
This sounds great, though requiring "offering 80% of the workforce stock" and excluding highest paid executives seems vague - is this at time of hiring, when stock is issued, fully vested, when taxes are due, somewhere inbetween? I parted ways with a startup in the valley last year and exercised some shares on January 13th. If I had exercised just two weeks earlier, I'm told I would've been hit with north of 50k in AMT, I have until next year to figure it out now but I wonder if I'm eligible. Also curious how long it typically takes to get from house, through the senate and passed.
From the bill, a corporation qualifies (aka the current state of affairs) if...
such corporation has a
written plan under which, in such
calendar year, not less than 80 percent
of all employees who provide services
to such corporation in the United
States (or any possession of the United
States) are granted stock options, or
restricted stock units, with the same
rights and privileges to receive
qualified stock.
I still don't understand why taxes are owed. If an option at the time of grant is worth $0 (which is how it's typically done or is that not the case?), then you don't owe anything to the IRS until you exercise the option, i.e. buy shares at the option price and sell them at presumably higher valuation and make some money, at which point you will need to part with some of it because it's income.
But if you never exercise the options, then you never owe any tax. What am I missing here?
If you exercise your ISO options (because of option expiration clauses, typically 90 days after you leave a company), but then don't (or can't due to no market for the shares) immediately sell those shares, the spread between the option grant price and the current 409A valuation is due as AMT tax. You have not realized an event where cash is in your pocket, but you still owe tax on the "gain".
You ask what does it matter if the options aren't exercised. Excellent question! It means all that potential compensation you were offered (because you took a lower salary usually in return for options) is now worthless. People don't want to work for free, or have their potential future compensation evaporate.
I see... So what should in theory fix it is if the company granting you the options also provided a guarantee that they will buy shares from you should you be inclined to sell them (A sort of a "sell at current price" option I suppose). This way you can exercise the options, and sell enough shares to cover the tax obligation and hang on to the rest.
Bookmarked to come back later to add detail. There is a better way where your company lets you exercise all your options immediately when you're hired, and you return non-vested shares when you leave.
Frequently, companies have a 90-day exercise window on options, meaning that employees have to exercise within 90 days of termination of employment. What that often translates into is employees sticking around indefinitely at companies whose value has grown during their tenure because they:
- can't exercise options and leave, because they would have to pay potentially huge taxes on an illiquid asset
- don't want to lose their stock, which makes up a nontrivial part of their comp for effort already invested in the company
So, your understanding is correct - but people often don't want to wait for a liquidity event to be able to exercise and don't want to miss out on something they already earned.
An example: as I hear it, there are quite a few early Uber employees sitting on tens or hundreds of millions of options who can't leave because if they exercise, they'd be slammed with millions in taxes. Since Travis Kalanick disallows secondary market trading of Uber stock, they wouldn't be able to sell stock to help pay the taxes, and thus can't afford to exercise but can't afford to leave. That's how you end up with employees who just come in to work the minimum possible amount waiting for an exit.
More evidence as to why the income tax should be replaced with a consumption tax. Just let people make their dammed money already and apply a simple tax when they spend it. Windfalls wouldn't be "dangerous" or punitive in that model, and savers would be rewarded.
--Of course I oversimplify the consumption tax, and safeguard would need to be in place on that to ensure it is not regressive with respect to necessities...
High consumption tax creates an incentive to not spend your money, which is bad.This also means the millionaires and billionaires of the world get to invest their money tax-free to earn even more money, often with rent-seeking, while 95% of America is getting taxed essentially up front on the vas majority of their earnings because it gets spent on stuff like housing, food, and healthcare.
This creates a massively regressive tax system, which is a super shitty thing unless you're a libertarian who can't understand the concept of marginal utility.
So you are content with having a tax system that treats you like a 1%er in the event that you cash in a payday (say $1mil - 35-40%) during a given year, despite the fact that you may have worked your whole life at a middle class level, scraping to save? A consumption tax would allow individuals to actually make choices about how/when they are taxed. Lets be honest, people will still want their "stuff". If they have more money in their pocket, they will spend. That is what America is built on. I would like the opportunity to defer spending at my choice in order to save more in the present without being taxed into oblivion.
And I'm sorry if you didn't read my entire comment. Of course an ignorant consumption tax is regressive. SAFEGUARDS would have to be in place to ensure that the population can acquire necessities without an undue burden being placed on them. Exactly the things you mention: housing (single home), food, healthcare. However, 50"+ 4K TVs do not fall in that category. 30' fishing boats do not fall in that category. Certain items in sales tax heavy states (Texas) already do this is the form of tax free checkout for certain item classes (food at grocery stores).
If I normally make 60k a year and get a one-time payday of $1MM, I'll be paying around 13% more in income tax on that million dollars than I do on my regular income. Even with AMT it isn't a huge deal. This seems pretty reasonable to me. It's not perfect but it's not a reason for completely eliminating income tax. It's a reason for having exemptions, which is exactly what this article is about.
>If they have more money in their pocket, they will spend. That is what America is built on.
This is simply not true for people with millions of dollars. Look at the percentage of income spent for someone making $500k a year, and the percentage spent by Bill Gates or any other billionaire. It's a huge difference, and there's a huge difference between both of those groups and someone making $100k a year who is usually spending almost all of their income. Consumption tax is also completely ignoring the "spend it overseas" and million other loopholes.
I am not convinced any method of consumption tax I've read about, regardless of safeguards, would retain the same level of tax income the government receives while also not increasing the burden on lower and middle income households. The vast majority of tax revenue comes from an extremely small percentage of earners, and you'd be losing the vast majority of that income if you only taxed their spending.
The only way I can see this working is if you almost exclusively taxed things rich people bought. Increase sales tax on homes over $1 million, cars and boats over $200k, private jets, etc. But the tax rate on these would have to be ridiculously high, more than doubling their costs. All the rich people would just buy them overseas.
$60,000 income with std deduction and personal deduction equates to a tax burden of $8,219 or effectively 13.7%.
$1,060,000 income equates to a tax burden of $406,314 or effectively 38.3% (treated as a short term capital gain).
That is money I could have saved and invested BEFORE being taxed an extraordinary rate for it relative to my place in life. I happened into money when I'm typically taxed at <14%, and nearly 40% of it is taken from me. Simply because I earned it over the span of 12 months. What if I built a company over 10 yrs and that is the culmination of that?
>> All the rich people would just buy them overseas.
That is a fair point. That said, if I buy something overseas from Europe right now, I don't pay VAT (coming from US). A large number of vendors compensate for this and keep the prices for US purchasers high and not an exact match to their Euro prices. So I think in practice you would see overseas retailers raising their prices to come close (or match) the US price that includes the consumption tax. That would balance out and lead people to do the easy thing and just buy in the US. Maybe... Maybe not...
> All the rich people would just buy them overseas.
You can't live in a home you buy overseas without living overseas. As for cars, boats, and planes, you pay consumption based taxes when you register them - that's the way state sales tax works on such things in most places today.
Obviously you're being sarcastic - you're right, the money gets spent eventually. But not by the billionaire. It gets spend by his kids, and his kid's kids, and so on, for generations. Meaning money that should have been taxed once in a single year is instead taxed over the course of 200 years and increasingly so on tax-exempt consumption. Meanwhile, that tax-free money is being used to invest in rent-seeking enterprises, meaning the cost of living for everyone else is being driven up. It's essentially a free loan from the US government for decades upon decades.
Totally agree! A consumption tax with a tax prebate (aka basic income guarantee) makes it progressive.
To head off the argument that it's regressive because wealthier people spend a smaller fraction of their income: true for a snapshot in time, but not over the course of their lives. Spending a fraction of your income = saving = spending later. So in retirement they could have an effective >100% income tax rate. Also, switching to this program would be a one-time double-tax on savings which will disproportionately affect those who've saved more; i.e. "progressive". I'm still not positive about intergenerational wealth transfers - that could be a way to avoid paying taxes, but maybe if we charged wealth transfers the same consumption rate, that could solve it.
I'm a big fan of a FairTax-esque approach since it simplifies things dramatically and lays the infrastructure for ramping up the prebate as time goes on, as our nation can afford it.
> Also, switching to this program would be a one-time double-tax on savings which will disproportionately affect those who've saved more; i.e. "progressive".
i.e. "putting retirees out on the street". Such a bill would need to provide a fix for that case, where someone has a fixed amount of savings intended to provide for themselves in retirement and cannot afford a sudden 10% increase in all prices.
For instance, one possible patch would be to look at people's lifetime income (already tracked by the Social Security Administration), and offer a one-time exemption up to a certain threshold, effectively calling the corresponding savings "already taxed" and providing an exemption. The challenge would be doing that without creating massive additional complexity in the tax code after that one-time event.
(This would only apply to people with post-tax retirement savings. The solution for pre-tax retirement savings is much simpler, since it won't get taxed at withdrawal anymore.)
> I'm still not positive about intergenerational wealth transfers
They wouldn't matter anymore, because they're all on the income side, and taxes would all be on the spending side. By taxing when the money gets spent, rather than when the money gets made, you no longer care where the money comes from.
You also no longer care about people who made their money in other jurisdictions, or many other issues. If you live in a country, you'll need to spend money in that country.
> I'm a big fan of a FairTax-esque approach since it simplifies things dramatically
Hopefully, but there's a pile of additional complexity involved in definition, to deal with suppliers and intermediate goods. There's a ridiculous amount of complexity in the definition of VAT; some of that is unnecessary bought-and-paid-for exemptions and adjustments on item types, but even after avoiding that, there's a pile of complexity involved in what "value added" means.
But wouldn't this encourage the rich to spend overseas? They would pay no tax on their income, and then they'd be free to go and spend it abroad in countries where there is an income tax, but no/lower consumer tax.
(I'm assuming you meant "travel and spend", rather than "order for shipment", since the latter is handled by applying sales taxes to imported goods.)
First, if they're traveling that often, they're going to be paying a substantial amount of travel expenses, subject to sales tax. Might also be worth considering if currency conversions should be subject to sales tax.
Second, who can afford to do the majority of their spending in another country, while not actually being a resident of that country instead?
Third, a country would get significant additional tax revenue from visitors and tourists, who don't make income in that country but do spend money in that country.
Fourth, where's the money coming from? The business they derive their income from has to pay sales taxes too.
And finally, a vanishingly small fraction of people could actually do that, and it's not worth making the tax code a hundred times more complicated to target a tiny number of people who will still end up paying a huge amount of tax in other ways. The administration alone isn't worth the additional revenue; you'd spend more administrating the more complex tax code for everyone than you'd have any hope of recouping.
Rather than a consumption tax (i.e. VAT or GST) a better tax would be an asset tax. Of course such a tax would be highly unpopular with the rich so it has zero chance of ever being implemented.
Interestingly, the currently-most-prominent plan in the US for a consumption tax includes a government "prebate", a pre-allocated consumption allowance based on household size, that amounts to a basic income. Under this proposal, every month, the federal government would send you a check for the household's consumption tax rebate (which is typically going to be in the hundreds of dollars).
Which seems highly preferable to a complex system of what to tax and what not to tax. Rather than maintaining an ever-changing list of what should and shouldn't have sales tax applied (with associated busybody politics on various items), just effectively exempt the first $X of purchases, whatever they might be.
I don't know. If I were self employed, and you buy a thing from me, is that your consumption (taxed) or my income (untaxed)? This stuff is complicated.
... thinking about it further: A truly crazy idea would be a consumption tax that is based on the income of the seller, to keep it from being regressive. Things from rich people are more expensive as a result, providing a nice anti-monopoly, anti-inequality balance. Now I want everyone to poke holes in why it would fall apart.
My thought is that this would be problematic in markets with natural monopolies. There aren't a lot of mom-and-pop power companies. (There are plenty of moms and pops selling power, but as I understand they sell it to the power company who resells it to you by burning less coal.)
Interesting idea about a progessive consumption tax. But would it be more costly to collect than income tax? Not to suggest that it isn't worth the cost: consider sales tax vs VAT. VAT is more expensive to collect but harder for businesses to evade.
My "luxury" VC fund features investor meetings three times a day, with meals and drinks provided by top-rated chefs and bartenders. Hell, for a higher "management fee," we'll even let you stay at our "offices".
Why all the goofy eligibility rules? Just get rid of the rule where exercising stock options counts as income under the AMT(1). It's line 14 in Part 1 of Form 6251. Just get rid of it!
When people talk about our tax system being too complicated bills like this are why.
1. For that matter we should get rid of the AMT entirely. The fact that we have 2 separate tax systems for individuals is insane. That's a bigger story though.
> For that matter we should get rid of the AMT entirely. The fact that we have 2 separate tax systems for individuals is insane.
It really is. The AMT is the perfect example of when you give someone an inch they take a mile, which is why some people fight so hard against the enactment of new taxes.
The AMT was originally enacted to catch a handful (less than 200 I believe) people who were at the time of enactment (1969) very rich and who were paying no taxes. These people had an AGI of over $200,000. That's $1.2 million in today's dollars. The AMT now affects over three million tax payers, mostly because for many years, the exemption was not properly indexed to inflation.
> The AMT is the perfect example of when you give someone an inch they take a mile, which is why some people fight so hard against the enactment of new taxes.
When the politicians were first proposing the constitutional amendment that allowed income taxes, they were throwing numbers like 1% or 2% around. It took only 4 years from the ratification of the 16th amendment for the maximum tax rate to shoot up from 7% to 67%. Now you get an effective 50% tax rate in some states. No wonder office workers spend so much time unproductively checking email and Facebook - that's the half of their time they're giving to the government.
Here's a history of the federal tax rate. Notice how it shoots up around World War 2, and takes a very long time to change even after the war ends. So it can't be that the taxes are high simply to fund government services that naturally arose:
My understanding is that the federal government cannot impose a property tax, without just distributing it to the states by population. My reading of the commerce clause is that they couldn't impose a sales tax on in-state commerce. So it's not like these went away after they gained the power to assess an income tax: they were never an option.
As a general rule, you could remove any government agency created with the increase in wartime tax revenue after the war is over. That should get you back to the pre-war tax rate.
I don't want to go down the entire list[1] of agencies, since it would take the thread too far off-topic(even this response is borderline). I should shift more work to the individual states. Also cut the military: They are so disorganized they're the only government branch that can't be audited[2].
> My reading of the commerce clause is that they couldn't impose a sales tax on in-state commerce.
(1) The commerce clause is a grant of power, not a limit. It's indisputable that the commerce clause does not authorize a tax on in-state commerce, but it doesn't prohibit one, either. So we need to look beyond the commerce clause and ask if a federal sales tax is authorized anywhere else.
(2) The dollar value of sales is income, derived from sales. The 16th Amendment gives Congress the authority to "lay and collect taxes on income, from whatever source derived, without apportionment among the several states". Therefore, a federal tax on the gross income from sales is authorized by the 16th Amendment.
(3) But, wait, we don't even need the 16th Amendment. There's a special word for a tax on sales of goods -- its called an "excise". And its an express Constitutional power of Congress even before any amendments, in the Tax and Spending Clause, with the restriction that they must be uniform throughout the United States.
As a general rule, you could remove any government agency created with the increase in wartime tax revenue after the war is over. That should get you back to the pre-war tax rate.
Pre war federal spending was ~10% of GDP. Currently we're at about 25%. So you want to cut federal spending by about 60%.
Medicare is about 15% of the fed budget. Social Security is about 25%. That's the 40% you get to keep right there. You think we should cut literally everything else?
Your assessment about what it would take to achieve the cuts you propose is not based in reality.
It may help to think of the suggestion as more a "We never should've passed it in the first place" rather than a suggestion to immediately propose a bill of repeal.
I have some thoughts on how to conduct an orderly shutdown of the programs over, say, 30 years, but they would take the thread too far away from the subject of stock options.
It would be better if the income tax was zero and we had a higher tax on consumption (allow a base deduction for poor people if you want) since what you tax you get less of, and we don't want less investment in human capital or physical capital, but less consumption is okay (though obviously still undesirable).
As for the rest, just cut all subsidies to companies and farms, as a start. Then cut the military down to what is needed to defend the US, not to waste money running an empire.
Our food import rate would climb due to the strength of the dollar. Which is fine for the short term. If bad things happen in 20 years and we can't even grow enough good to feed the country? That seems pretty bad.
We have 52 different tax systems for individuals by my count. All the states have have different rules too. Last several years, my wife and I have had to figure out our taxes five different ways on the same income.
What the house needs to do is regulate startup's shady options agreements. I see way too many developers getting burned out striving for that big payout that may never come. It's the classic con game.
Companies have the right of first refusal and don't like lots of unrelated people on their cap table who only hold a small amount of shares, so don't expect this to work out
Apart from adding complexity to future funding rounds, companies don't like having many different owners of shares because there's an upper bound on number of distinct stockholders above which you're considered a "public" company and have a pile of additional obligations.
I would check out sharespost, equityzen, or equidate (and also search for them on Hacker News, as I found others mention experience with sharespost). I don't have direct experience, but I was helping a friend with a number of shares in a late stage startup research the sell side, and those are the companies that came up.
It crossed my mind to buy shares but I haven't done so. For some of them, you have to be an accredited investor, which means a certain net worth/income threshold to be met. (I think the SEC is trying to prevent naive investors from getting fleeced in this "dark" market). SharesPost seems to have a fund that gets you exposure to a lot of late stage startups.
AngelList apparently has a fund for early stage startups... if anyone knows anything about that I would appreciate any feedback.
EDIT with more info: From my research, buying from every company is different. That is why companies like SharesPost exist. And you really should have the permission of the company to do the transaction.
I think it may be possible to do it without their permission, but that's beyond my knowledge. There should be employees willing to go through this effort because they stand to benefit because you are offsetting their tax risk.
I don't know since I haven't used them yet. I imagine the middleman is fairly well aligned with you because their business model is to take a cut of the transaction. If they're getting 5% of a $100K or $500K transaction, that's a fairly good incentive not to try to screw people over. Disputes cost time and money.
The party that isn't aligned is the employer. As mentioned, they hold right of first refusal, and they may balk at having "strangers" on the cap table.
I'm sure there is a whole bunch of "interesting" paperwork and if you had a lawyer look at it they would gladly take your money. I believe each company is different, because the way you hold private shares depends on the company governance. SharesPost has presumably done some of the legwork for you because they are advertising this facilitation only for specific companies, which they have hopefully vetted in some way.
I imagine that SharesPost exists precisely because people had to get lawyers and accountants involved to do these custom transactions, and now they are pushing it to the lower end of the market. But they are also fairly new so they can't be perfect.
How does this relate to the push for startups to change from a 90 day to 10 year exercise window? It seems like that's a better option than this bill since it gives employees a larger time window to make an exercise decision, during which the likelyhood of options actual resulting in something liquid is much higher
Perhaps I'm misreading the law, but it looks like it solves the wrong problem: It addresses a cash-flow issue rather than the tax liability issue.
Say you have options at FooCorp and you leave. FooCorp is illquid and you have 90 days to exercise your 10,000 options. Your FC options have a $5 strike, but the company currently has a 409a valuation of $100/share.
To exercise the options you would need to pay $50,000 to FooCorp, then you would have a "realized gain" 950k (($100-$5)*10000 which you would owe 28% of in taxes that year, or 266k. So you would need access to $316k in total in order to exercise these options.
Two issues arise: (1) You may not have $316k just kicking around. (2) THE SHARES ARE ILLIQUID AND MAY BE WORTH $0 WHEN YOU CAN ACTUALLY DO ANYTHING WITH THEM.
The bill appears to help with (1) by letting you pay that 266k not now-- but later when the company shares become liquid or 7 years (whichever comes first). But it does nothing about (2) -- you might exercise and then the company goes bust, and seven years later you owe $266k and your current position is worth -50k... and because the taxes are AMT, you can't meaningfully write them off your losses against the taxes you owe.
This kind of failure doesn't require FooCorp to fail. You could have options at $5, execute at $100, and have things go liquid at $7-- ignoring taxes this would have been a $20k gain. But with the taxes you're still $246k in the hole.
The issue all along wasn't that someone needed extra money. The issue was the potential huge losses. If it weren't risky you could find a lender to cover the execution price and taxes in exchange for a return when the asset becomes liquid. (E.g. having to pay the $266k up front but getting it returned later when the asset becomes worthless and you write it off)
If anything this makes the situation worse by encouraging more people to commit financial suicide by making it less obviously a bad idea while being just as risky as it always was.
> Only startups offering stock options to at least 80 percent of their workforce would be eligible for tax deferrals, and a company’s highest-paid executives would not be able to defer taxes on their stock under the legislation.
>In the United States, this approach impacts personal tax liability, because although stock and option grants are taxed at federal income rates, they may be exempt from some portion of payroll taxes (typically 7.65%) used to fund Social Security and Medicare.
They're still considered highly-compensated, just not through payroll.
$1 salaries is because they get paid through a complicated structure that eventually means they owe capital gains tax (20%) instead of income tax (40%).
How would this affect the concept of phantom stock options? I worked at a startup who used the main excuse of no taxes paid handing out ghost options instead of normal options.
"Phantom stock can, but usually does not, pay dividends. When the grant is initially made or the phantom shares vest, there is no tax impact. When the payout is made, however, it is taxed as ordinary income to the grantee and is deductible to the employer."
Just because the house passes a bill doesn't mean it's a law. It also has to pass the Senate and be signed by the President (or go through the veto process).
The article appears to get the "seven years" qualification wrong. The bill states that tax must be paid at:
>> the date that is 7 years after the first date the rights of the employee in such stock are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier
Which implies that transfer-restricted stock grants do not start this clock ticking.
I am wondering if there will be additional complexity added to the rule making phase of this if it becomes law.
While this amendment is short in length, it seems to add additional complexity to an already complex tax code. I would have liked to have seen an even simpler proposal.
To be perfectly honest, this bill affects mostly middle class near as I can tell. The following is entirely personal understanding of my own stock option agreement and is subject to mistakes and misconceptions...so someone can feel free to correct me.
The problem this bill targets is the "exercise tax" interaction. Say you are an employee at a start up. Said start up can't afford your full normal salary so they pay you something less but offer you the OPTION of PURCHASING stock in their privately held corporation at a fixed rate (stock options) and often at a "discount" (more on this below).
So a private "board" (of the company) meets and arbitrarily assigns a dollar value to the shares of their company...again this is more or less arbitrary since all stock is privately held so there is no market interaction for price setting. Based on this dollar value, they offer you, the employee, a "discount". So if your board sets a price estimate of $1.50 per share, they might put in your stock option agreement a fixed price of $1.20 per share for X number of shares.
But this means, at least according to tax law, that when you purchase the stock at $1.20, you, the employee, have an IMMEDIATE realized gain of $0.30 per share...lucky you! So this is of course taxable.
Problem being that the current share "value" and the corresponding discount was arbitrarily assigned and actually...you spent $1.20 on a share of a company that has no resale value. So not only do you "buy" (or "invest") into ownership of your start up...you then get taxed on top of it for a "realized gain" that actually doesn't exist. So it's not like you can turn around and sell some of your new "stock" to be able to pay the tax...
You have the gist right but a couple of corrections:
1) The board doesn't set the price arbitrarily. They engage a 3rd party accounting firm to do a 409A evaluation of the company. The 3rd party essentially sets the price. It's true that determining a market price for private company stock is just as much art as science but it's not completely arbitrary.
2) The company ABSOLUTELY CANNOT offer stock options at a discount to the 409A. There is a good chance people would go to jail these days if they did that.
3) The discount that you are talking about is the discount from preferred stock (which investors generally hold) and common stock (which employees generally hold). Preferred stock is legitimately more valuable because of various privileges attached to it that are not attached to common.
4) If you immediately exercise your stock upon granting you won't face an "exercise tax" interaction because the price at which you exercise will be the same as your strike price. If you can afford it this, is often a good idea. You have to file some paperwork with the IRS called an 83B to do this right.
5) It's when you wait some period of time that you can face an exercise tax. This is because over time the company will do additional 409As and if the company is succeeding those will indicate that common stock has risen in value. It's that difference that you might have to pay taxes on. It's this tax that this bill aims to let you defer.
> 2) The company ABSOLUTELY CANNOT offer stock options at a discount to the 409A. There is a good chance people would go to jail these days if they did that.
Absolutely false. A company can create an option, a warrant, etc. with whatever kind of terms it likes, so long as the board approves and it's permitted by the applicable state law and charter.
The only thing a 409(a) valuation does is provide a "safe harbor" for the company and the employee, that allows them both to rely on the valuation as fair market value for tax & accounting purposes (for the company, so that it doesn't need to expense the option; for the employee, so that there's not an immediate taxable gain upon vesting).
The board, in fact, can make its own determination of fair market value without a 409(a) valuation. But if they do that, they blow their safe harbor and the burden of proof is on them if the IRS comes knocking. So no competent counsel is going to let you go around making up your own FMV.
Finally, I'm pretty sure that a board could even issue options that didn't even pretend to be at FMV, but were at some unconstrained number. There's very good reason, for example, to issue out-of-the-money options when you want people to have skin in the game. There's probably some conceivable reason to issue an in-the-money option, too. (If you do this, though, you are likely condemning both your company and your optionee to a pretty dark slog through the thickets of tax law.)
It is true that there were some criminal (and civil) sanctions tossed around for options shenanigans in the dot com 1.0 days, but they were mainly due to public companies blatantly back-dating options to specific days when the stock price was down, so as to provide guaranteed value to options recipients, without the company needing properly to account for the expense.
OK ya, that's all fair. I overstated. I will amend my comment to say that if companies do offer options at a discount to the 409A everyone involved needs to be very very very careful about tax laws or bad things can happen to both the company and the option grantee.
See I knew there would be someone else on here who knew better :)
Anyway, my only elaboration on point 4 and 5 is that most options agreements have vesting ~~terms~~ schedules (and they typically include 1-year cliffs). So even under ideal conditions you will have to wait a certain amount of time before exercising.
But thanks for taking the time to add additional details!
409A isn't an arbitrary number the board makes up. Private co's pay external firms to do market research and sift through internal financial/key metrics to derive that number.
Your scenario of an immediate $.30 tax liability because of an arbitrary discount also isn't correct. 409A is recalculated on some interval (quarterly generally) and those price changes determine your stock's new value and subsequent tax liability, but only when you exercise options/sell shares.
The common stock discount you're referring to is when there are preferred shares granted to an investor, but common is still determined by an external firm.
While I think you are possibly correct...I think removing this is more difficult since it has much deeper implications for private investing. Say some investor wants to invest in your private company, without some sort of 409a company worth...how would you go about negotiation?
To be fair, I oversimplified when I said "arbitrary"...company valuation estimates aren't _completely_ random...they just aren't set by free market interactions.
The current/old method coul create severe Problems for the employee:
People working for an extreme very successfull Startups like Google, Facebook and the like, could become very rich on paper.
Imagine an income of 200 Thousand and quite suddenly 2 Million in Stocks.
Now they had to pay taxes on the 2 Million from their normal income, since they couldn't or didn't want to sell their stock Options yet.
The argument could be made that this is actually a gift to businesses and executives.
Ultimately this bill makes working at a startup more attractive when they are already a pretty poor choice, so we'll just have more people making poor choices and putting themselves at financial risk to the benefit of their employer.
This makes it so employees can actually participate in the upside of the risk - something that the current tax setup can make impossible for employees of highly valued private companies.
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I'm Bob, I write a check for $50K to exercise my stock options. They might be worth something some day, I'm taking that risk and working my ass off to see that they are.
The year I exercise the options, the gov sees that I've made a $1.5M "paper gain", and they want their taxes. Call it $300K.
If Bob doesn't have $350K in the bank, he is stuck - he basically needs to wait until said company goes public to make a zero-cash sale, or forfeit his options when leaving (either by quitting or getting fired).
Not to mention if Bob exercised the stock and payed the $350K - the company could never IPO, or it could and tank. Bob wouldn't see any of that money back.
Bob's upside for working at said risky startup is severally limited.
This is a surprise to most employees, who accepted the risk and assumed they would be able to participate in the upside of the startup (kind of the whole point). These employees find out that, in many cases, they can't actually become shareholders, or they do and lose everything.
In concept, this bill would have Bob write the $50K check for the options, and then only pay taxes once and if actual liquid gains were realized.
How does this only affect the rich or somehow incorrectly incentive people to work for startups?
Given most employees at "startups" are actually later employees when the companies are larger and less likely to fail, it may actually be that most of them get some sort of payday, even if it's not huge.
While this is certainly an argument, I think the bill fixes an unintended interaction in tax law where people were getting taxed for "realized gains" that actually weren't realized...or gains at all (yet).
So an alternative way of looking at it is that this bill removes an _accidental_ disincentive for innovation.
AMT has since emerged to devour the value of this benefit. By having to include the value of the spread (difference between exercise price and fair market value of the stock on date of exercise) as AMT income and pay tax on it at 28%-type rates, an employee can incur great tax risk in exercising options - especially for a venture that is in advanced rounds of funding but for which there is still no public market for trading of the shares. Even secondary markets for closely held stock are much restricted given the restrictions on transfer routinely written into the stock option documentation these days.
So why not just pass a law saying that the value of the spread is exempt from AMT? Of course, that would do exactly what is needed.
The problem is that AMT, which began in the late 60s as a "millionaire's tax", has since grown to be an integral part of how the federal government finances its affairs and is thus, in its perverse sort of way, a sacred cow untouchable without seriously disturbing the current political balance that is extant today.
And so this half-measure that helps a bit, not by eliminating the tax risk but only by deferring it and also for only some but not all potentially affected employees.
So, if you incur a several hundred thousand dollar tax hit because you choose to exercise your options under this measure, and then your venture goes bust for some reason, it appears you still will have to pay the tax down the road - thus, tax disasters are still possible with this measure. Of course, in optimum cases (and likely even in most cases), employees can benefit from this measure because they don't have to pay tax up front but only after enough time lapses by which they can realize the economic value of the stock.
This "tax breather" is a positive step and will make this helpful for a great many people. Not a complete answer but perhaps the best the politicians can do in today's political climate. It would be good if it passes.
Edit: text of the bill is here: https://www.congress.gov/bill/114th-congress/house-bill/5719... (Note: it is a deferral only - if the value evaporates, you still owe the tax).