A proposed tax that charges people as their startup equity vests instead of when they cash it out and actually have money to pay the taxes could wreck how tech companies recruit talent. And the industry doesn’t have much time to mobilize to get this tax changed. The U.S. Senate released its proposed tax reform bill late last week under the aggrandized “Tax Cuts and Jobs Act.” It includes a tax on stock options and Restricted Stock Units (RSUs) that applies as they vest, rather than using the existing scheme that taxes stock options when they’re exercised or when the underlying shares are released for RSUs. As famed VC Fred Wilson of Union Square Ventures explains, “What this would mean is every month, when your equity compensation vests a little bit, you will owe taxes on it even though you can’t do anything with that equity compensation. You can’t spend it, you can’t save it, you can’t invest it. Because you don’t have it yet.” That’s a huge problem. Because if you’re not already quite wealthy, you might not be able to afford to pay those taxes until you actually liquidate your equity for cash. The proposed tax could prevent wide swaths of tech employees from accepting stock options and RSUs. This breaks the whole incentive structure for top talent to take intense jobs at companies with a risk for failure because there’d no longer be the potential for massive upside. If there’s no shot at getting rich for grinding it out as an early employee at a startup, top talent won’t take those jobs. UNITED STATES – OCTOBER 04: Amanda Werner, who is dressed as Monopoly’s Rich Uncle Pennybags, sits behind Richard Smith, left, CEO of Equifax, during a Senate Banking, Housing and Urban Affairs Committee hearing in Dirksen on the company’s security breach on October 4, 2017. (Photo By Tom Williams/CQ Roll Call) Companies would have to shift to higher salaries and big bonuses to attract the best employees. But startups often don’t have the cash to do that. In order to attract talent they rely on equity that’s free to dole out at the time and only worth a lot if the company succeeds. This could push top product, design, engineering and sales people to work at bigger, established companies that can afford juicy salaries and bonuses. And with fewer equity-made millionaires and billionaires, there will be fewer people investing in the next generation of startups. This in turn could reduce innovation, prevent the disruption of aging giants and lower the U.S. tech sector’s competitiveness with the world. There’s no doubt that the tech industry is frothy, tons of people are accumulating huge wealth via equity and they could probably afford to pay higher taxes. But that’s only after they’ve earned their fortune by liquidating equity. A tax on vesting dissuades people from ever taking a swing for the fences. [Update: One policy option would be to follow Canada’s lead, where vesting is taxed but smaller private corporations like startups get an exemption. Otherwise, if the law goes into place, startups might have to adopt profit sharing models to attract talent. But that would only help certain fast-to-profit startups, not the build/grow now and monetize later startups that often become the biggest.] Wilson recommends that people who want to fight this should call their senator, speak with the aide covering tax reform and ask for this tax on vesting to be changed or removed from the Tax Cuts And Jobs Act. The Senate could potentially try to push the Act through before year’s end. And if the vesting tax becomes law, it could wreak havoc on the startup world.
I'm a bit confused by the terminology of "vested". I understand unvested securities to be assets granted to someone that are in the process of vesting and once vested can be sold or exercised by the employee. I was under the impression that there is no tax until the assets are vested. The value of the assets at the time that they are vested is considered to be income and reported to the IRS. Any gain or loss from the cost basis at time of vesting is interpreted to be a capital gain or loss. Is that right?
Non-qualified stock options are currently not taxed at vesting, only when you exercise the option to purchase the stock, so your understanding was incorrect for NSOs (and ISOs). The proposed law would change them to being taxable at the time of vesting, which would absolutely destroy the startup world. Why the fuck supposedly pro-business, pro-economic growth Republicans would want to cause this much damage to the biggest job and economic engine in the country so that they can reduce corporate marginal rates is simply baffling. I own all of my current company, so not impacted by it, but this would have had a major negative impact on my first company and thousands like it. Just crazy. What's wrong with these people?
I don't love taxes, but I kinda see the logic of taxing stock once it is vested and therefore, by definition, if my understanding is correct, can be sold by the employee. I don't see any difference between a company granting 100 shares of stock to the employee vs. the company granting a cash bonus to the employee that could be used to purchase 100 shares of stock. Both are forms of income from the perspective of the employee. However, if the government tried to tax the value of unvested shares, that could end tragically and would not make sense because it's not an asset that the employee can do anything with. The employee would basically be forced to pay taxes on an asset that he or she doesn't really have. I really don't see that ever happening.
I know that was a rhetorical question so here's my snarky answer: To help the googles and the goldmans compete for talent. There, you pay taxes when your stock vests.
Its not stock people, it's options! You do pay tax now when your stock vests or when you exercise your non-qualified options. They want to change it to a taxable event when an option vests. An employee stock option can't be sold. So if you're talking a small company you're talking about using options to attract talent you can't afford to pay market rates, and setting up an incentive structure where they're directly compensated by the positive impact on the company. You make them pay taxes when the option vests, you have to pay them a lot more, at least enough to cover those taxes. Plus you have to pay a somewhat significant amount (relative to your company's value) to have a qualified third party not only value your startup's stock, but also potentially determine the volatility of that non-trading stock to determine the options value. Why you would want to disincentivize startups through the tax code is inexplicable, unless as @newwurldmn pointed out it's just a cynical big company ploy to make it harder for startups to exist, therefore reducing competition both from the startups products and for their workers. Who's voting for these people again?
Another rhetorical question deserves a snarky answer: Poor people who are focused on keeping the brown people out while the republicans give rich people nice tax cuts.
Sadly may be true in aggregate, but probably not for the vast majority of the people here who really believe the tax plan is a good idea from an economic perspective. Just trying to point out that at least this part of it is the antithesis of what they truly believe is good, in the hopes that they'll take an active role in influencing it. Smart well meaning people can have legitimate disagreements about if a corporate rate of 35% or 32.22% or even 20% is better for the economy. This, though, is just idiocy.