4 ms·

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 agree

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...

bluejekyll 10y ago
This could have been resolved by also removing the 409a rule. Which requires companies to specifiy some arbitrary price that the company is worth.
- gshulegaard 10y ago
  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.
harryh 10y ago
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.
- gshulegaard 10y ago
  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!
  - harryh 10y ago
    You can actually exercise before stock has vested. If you leave the company before your stock vests they have the option of buying it back from you.
    - gshulegaard 10y ago
goseeastarwar 10y ago
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. Edit: harryh beat me because I type too slowly.
- gshulegaard 10y ago
  Sounds about right! Thanks for taking the time to provide additional details. Cheers!

bluejekyll 10y ago

This could have been resolved by also removing the 409a rule. Which requires companies to specifiy some arbitrary price that the company is worth.

gshulegaard 10y ago
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.

harryh 10y ago

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.

gshulegaard 10y ago
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!
- harryh 10y ago
  You can actually exercise before stock has vested. If you leave the company before your stock vests they have the option of buying it back from you.
  - gshulegaard 10y ago

goseeastarwar 10y ago

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. Edit: harryh beat me because I type too slowly.

gshulegaard 10y ago
Sounds about right! Thanks for taking the time to provide additional details. Cheers!