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.
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.