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I'm going to say something that may be unpopular. Hopefully my karma can handle it. The latest analysis I saw of this from Fenwick says that this is only apply

by sulam 9y ago

I'm going to say something that may be unpopular. Hopefully my karma can handle it. The latest analysis I saw of this from Fenwick says that this is only applying to non-qualified stock options. Employees get NSOs when you vest too much to get ISOs in a calendar year, based on the vesting schedule and value at the time of grant, not fair market value at time of vesting of the option. That limit is $100K, for people who didn't know. [edit: clarified the issue of cap calculation since my original post was in error. The point doesn’t change.] Who else gets NSOs? Non-employees, like directors, for instance. This tax bill is pretty awful. However, it's not obvious to me that it destroys startup compensation -- ISOs will still be given to most employees, until you are getting too big for them, when you get RSUs, just like today. If anything your average tech employee will potentially do better -- I had to sell a ton of stock simply to pay AMT on the rest of the stock I exercised at my last startup. AMT goes away in this plan, so people won't have to deal with that issue.

hatred 9y ago
You seem to be bringing up a really good point. From reading the article earlier, I was under the false impression that this applies to ISO's too but looks like it only applies to NSO's. What about non-public RSU's for late stage startups like Uber, Airbnb etc?
- sulam 9y ago
  Those RSUs are a particular kind of promise, and it makes sense to use RSUs when the company has gotten very valuable because you hit the ISO cap pretty quickly and NSOs already have a tax-at-vest issue. My guess (IANAL) is that you'd just change the promise. "You will vest these RSUs when we go public and you can pay the taxes". I actually think there's _already_ an issue around this, because you can be vesting RSUs while the company is public but you are personally locked out and not allowed to trade them -- and yet you need to pay your taxes and the normal way to do that is to sell a portion of your RSUs. In the case I know of (Twitter), there was a special way of handling that on a one-time basis. I don't remember the exact details (it didn't apply to me), but they managed to work it out.
TimPC 9y ago
It depends a lot on the pricing of that $100K. If that's based on price at time of vesting you run into big problems -- that's not how ISO's work currently but it's unclear exactly what is going to change in this bill. Say you get $50K/year in stock at the valuation based on the time you join the start-up and the start-up has on paper 10X growth in 2 years. In your 3rd year, your $50K of stock is $500K on paper so the last $400K would be over the $100K limit and immediately taxable even though you cannot sell the stock yet. If the tax is setup to make $100K of value at time of employment contract exempt from taxing as ISO's, then the problem is far smaller as the tax events are predictible and manageable.
- sulam 9y ago
  I tried to be clear above -- the cap is based on the grant value, not the vested value -- ie it is strike price, not 409A (or other) exercise value. Really, if you think about it, it could only be this way. You can't predict the future value of your company. If I give you an ISO grant now, but the company doubles in value next year and puts you over the cap, we're in a pickle.
  - TimPC 9y ago
    The other thing to keep in mind is how much comp is the right to in the future buy $100k present value of stock for $100k. Even if that option prices at 20% the “100k” is only 20k of comp. For many positions 100k/year of stock may be too limiting. If there are ways to manipulate the share value of the class of shares you are getting to a small fraction then it might work. But if this excise price is the VC round price for a worse class of share the amount of comp here is fairly small.
    - sulam 9y ago
      The common vs preferred spread is usually enough to make this a non-issue unless you are a very well-paid executive. This is why I was careful to say the _average_ employee is likely to do better, strictly in terms of startup compensation.
pcl 9y ago
Per the article and my understanding from other secondary sources, the tax-at-vest clause applies to RSUs as well as NQSOs. RSUs are frequently issued by companies that do not have a liquid market. So, tax-at-vest is still problematic for that class of employee compensation.
- djrogers 9y ago
  One would assume that companies would stop doing this and issue ISOs instead.
  - hatred 9y ago
    Its not that trivial. ISO's have a $100k limit.
    - sulam 9y ago
      Yeah, there's a couple reasons for RSUs to exist and the cap is a big one (the other is shareholder limits). However, the issue is vesting, not the RSU itself. You can delay RSU vesting to happen at a liquidity event and the problems go away. That leads to a bad situation where employees are stuck holding their "earned but not vested" RSUs and can't quit (similar to what already happens to people who can't afford to exercise their ISOs, or even if they can, they get bombed by AMT and don't have a liquid stock to pay taxes with). This seems like a solvable problem. If all it did was cause companies to figure out how to make their shares liquid in some fashion (IPO, secondary market, private exchange -- something) that would be net-positive for employees.
      - CapnCrunchie 9y ago
        I worked for a company where RSUs did not vest until liquidity event. There were a lot of earned options that people still haven't been able to exercise. People that have been there for over 8 years. I just forfeited mine and moved on to a different company.
      - closeparen 9y ago
ccheever 9y ago
Do you have a link to this analysis? I couldn't find it online.
- slapshot 9y ago
  https://www.fenwick.com/publications/Pages/Proposed-Tax-Reform-Bill-Stands-to-Significantly-Impact-Equity-and-Performance-Based-Compensation.aspx https://www.fenwick.com/publications/Pages/Proposed-Tax-Refo... > The proposed bill leaves Section 422 of the Code, governing the taxation of ISOs, untouched, apparently exempting it from new Section 409B. As a result, ISOs may continue to offer employees eligibility to receive favorable tax treatment by deferring taxation until sale
  - sulam 9y ago
    Thanks, you beat me to it!
- deleted 9y ago
  [deleted]
js2 9y ago
That seems correct: However, it is intended that statutory options are not considered nonqualified deferred compensation for purposes of the proposal. An exception is provided for that portion of a plan consisting of a transfer of property described in section 83 (other than stock options) or which consists of a trust to which section 402(b) applies. Page 209 of https://www.jct.gov/publications.html?func=download&id=5031&chk=5031&no_html=1 https://www.jct.gov/publications.html?func=download&id=5031&... But I'm not sure how this impacts ISOs with an 83(b) election.
- sulam 9y ago
  I think in an 83(b) you haven't had a gain, same as today, so there's nothing to tax.
hedora 9y ago
It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant. (Yes, this rule is terrible for planning, because you don’t know what fraction of your shares are ISOs until they vest). Today, ISO’s are commonly given to engineers at pre-IPO startups. Nothing says they have to go to execs. Those engineers end up holding them for years before they can exercise, so $100K is a small fraction of a normal Silicon Valley startup, when you divide it out. Many startups take 6-10 years to IPO these days. Source on $100K cap: stock plan admins at work, and also this article: http://help.capshare.com/knowledge-base/what-is-an-iso-100k-violation/ http://help.capshare.com/knowledge-base/what-is-an-iso-100k-... Please do not comment on technical nuances of the tax code you do not understand. Misunderstandings around this stuff bankrupts people all the time. (especially the type of people that hang out here!)
- jalonso510 9y ago
  "It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant" This is not correct. The $100k threshold is calculated based on the fair market value of the option at the time of grant, which by definition is the exercise price. So you calculate how many shares you will vest in each year, multiplied by your exercise price, and as long as that is under $100k you are not over the limit and your option remains an ISO. If you're over, then the portion that exceeds $100k is treated as an NSO, but you can still get ISO treatment on the other part. I'm a startup lawyer and having worked with 100+ companies on their options, it's really not that common to get tripped up on this.
  - sulam 9y ago
    I misspoke in using the term exercise value. However (and you’re a lawyer so I’m going to believe you here) everything I’ve read or can make sense of says it is the value at time of grant that the cap applies to, not some fluctuating fair market value at time of vest. Is that correct?
loeg 9y ago
Also — I don't see any problem with forcing companies to compensate employees in cash instead of employer equity. Especially for publicly traded companies, employees can go ahead, turn around and plow that cash into company stock if they want to. (RSUs are just cash in the form of stock anyway.)
- sk5t 9y ago
  The issue is that the companies that most depend on options/SARs/etc. to get off the ground do not have the cashflow. Otherwise it would not even be in their interests to grant equity.
  - loeg 9y ago
    Again, I don't see that as a problem. Instead of paying their employees in cash and dreams, they're forced to just pay in cash. If employees are less keen on the same amount of cash without the dream, too bad for companies too marginal to pay a prevailing wage.
- sulam 9y ago
  >RSUs are just cash in the form of stock anyway. That’s an interesting point. They are and they aren’t. Cash as in actual dolla dolla bills they are not. Cash in terms of GAAP liabilities they are. But “stock-based compensation” is generally the largest part of what public tech companies exclude when they report non-GAAP earnings. And the lion’s share of those will be RSUs. Why do companies think this is a reasonable way to report? (Other than simply trying to look better for non-experts who don’t know how this stuff works.) The most obvious reason from my perspective is that this is a variable cost that is already baked into the model. The variable part is obvious — if I make a promise to give you 300 shares the value side is going to change over time. If our earnings are crappy and everyone sells the stock (to who?!) then the value of your compensation has just dropped. The cost side is also weird — these shares aren’t bought on the open market at time of vest, they are in employee pools that are set aside ahead of time (in fact my understanding is that the usual terms of an RSU require the stock to be set aside at time of grant). So theoretically they should cost whatever the fair market value is at the time the pool was created. Either way they aren’t cash that left the company’s bank account and went to the employee, like regular compensation. Accounting is hard!
zwily 9y ago
Thanks for this. I suspect that for most of the situations where people were (mistakenly) freaking out about their ISOs being taxed on vest, they will actually be much better off given the removal of AMT in the bill.
- robbomacrae 9y ago
  AMT started off with reasonable intentions but 47 years later it ended up effecting way more people than intended due to inflation. I feel like the $100k limit will end up doing the same.
- tomc1985 9y ago
  How does it apply to options already vested?
econner 9y ago
The problem though is that if you have ISOs they usually have to be exercised within 90 days of departure from a company. Some companies are extending that deadline to 7 years, but the IRS disqualifies ISOs 90 days after departure so they have to convert to NSOs. So this would prevent companies from providing an option extension.
- hkmurakami 9y ago
  I thought about this, and if the taxation trigger is "tax upon vesting", and the vesting is done when the options are ISOs, I would think that it is possible that this legislation is worded in a way so that an ISO -> NQO conversion does not trigger a tax event.
  - Bartweiss 9y ago
    Is it clear what tax impact the conversion has? Arguably that's the moment when you "vest NSO options", but then the entire tax blow would drop upon leaving the company, which would be particularly bizarre. (Is the proposed law even clear about how this would work?)
KerrickStaley 9y ago
Can you link to the Fenwick analysis that this is based on?
deleted 9y ago
[deleted]
godzillabrennus 9y ago
As a consultant who gives price breaks to early stage startups by taking options on a NQSO agreement this is often the only way to avoid getting taxed. This will suck.

by sulam 9y ago

hatred 9y ago

You seem to be bringing up a really good point. From reading the article earlier, I was under the false impression that this applies to ISO's too but looks like it only applies to NSO's. What about non-public RSU's for late stage startups like Uber, Airbnb etc?

sulam 9y ago
Those RSUs are a particular kind of promise, and it makes sense to use RSUs when the company has gotten very valuable because you hit the ISO cap pretty quickly and NSOs already have a tax-at-vest issue. My guess (IANAL) is that you'd just change the promise. "You will vest these RSUs when we go public and you can pay the taxes". I actually think there's _already_ an issue around this, because you can be vesting RSUs while the company is public but you are personally locked out and not allowed to trade them -- and yet you need to pay your taxes and the normal way to do that is to sell a portion of your RSUs. In the case I know of (Twitter), there was a special way of handling that on a one-time basis. I don't remember the exact details (it didn't apply to me), but they managed to work it out.

TimPC 9y ago

It depends a lot on the pricing of that $100K. If that's based on price at time of vesting you run into big problems -- that's not how ISO's work currently but it's unclear exactly what is going to change in this bill. Say you get $50K/year in stock at the valuation based on the time you join the start-up and the start-up has on paper 10X growth in 2 years. In your 3rd year, your $50K of stock is $500K on paper so the last $400K would be over the $100K limit and immediately taxable even though you cannot sell the stock yet. If the tax is setup to make $100K of value at time of employment contract exempt from taxing as ISO's, then the problem is far smaller as the tax events are predictible and manageable.

sulam 9y ago
I tried to be clear above -- the cap is based on the grant value, not the vested value -- ie it is strike price, not 409A (or other) exercise value. Really, if you think about it, it could only be this way. You can't predict the future value of your company. If I give you an ISO grant now, but the company doubles in value next year and puts you over the cap, we're in a pickle.
- TimPC 9y ago
  The other thing to keep in mind is how much comp is the right to in the future buy $100k present value of stock for $100k. Even if that option prices at 20% the “100k” is only 20k of comp. For many positions 100k/year of stock may be too limiting. If there are ways to manipulate the share value of the class of shares you are getting to a small fraction then it might work. But if this excise price is the VC round price for a worse class of share the amount of comp here is fairly small.
  - sulam 9y ago
    The common vs preferred spread is usually enough to make this a non-issue unless you are a very well-paid executive. This is why I was careful to say the _average_ employee is likely to do better, strictly in terms of startup compensation.

pcl 9y ago

Per the article and my understanding from other secondary sources, the tax-at-vest clause applies to RSUs as well as NQSOs. RSUs are frequently issued by companies that do not have a liquid market. So, tax-at-vest is still problematic for that class of employee compensation.

djrogers 9y ago
One would assume that companies would stop doing this and issue ISOs instead.
- hatred 9y ago
  Its not that trivial. ISO's have a $100k limit.
  - sulam 9y ago
    Yeah, there's a couple reasons for RSUs to exist and the cap is a big one (the other is shareholder limits). However, the issue is vesting, not the RSU itself. You can delay RSU vesting to happen at a liquidity event and the problems go away. That leads to a bad situation where employees are stuck holding their "earned but not vested" RSUs and can't quit (similar to what already happens to people who can't afford to exercise their ISOs, or even if they can, they get bombed by AMT and don't have a liquid stock to pay taxes with). This seems like a solvable problem. If all it did was cause companies to figure out how to make their shares liquid in some fashion (IPO, secondary market, private exchange -- something) that would be net-positive for employees.
    - CapnCrunchie 9y ago
      I worked for a company where RSUs did not vest until liquidity event. There were a lot of earned options that people still haven't been able to exercise. People that have been there for over 8 years. I just forfeited mine and moved on to a different company.
    - closeparen 9y ago

ccheever 9y ago

Do you have a link to this analysis? I couldn't find it online.

slapshot 9y ago
https://www.fenwick.com/publications/Pages/Proposed-Tax-Reform-Bill-Stands-to-Significantly-Impact-Equity-and-Performance-Based-Compensation.aspx https://www.fenwick.com/publications/Pages/Proposed-Tax-Refo... > The proposed bill leaves Section 422 of the Code, governing the taxation of ISOs, untouched, apparently exempting it from new Section 409B. As a result, ISOs may continue to offer employees eligibility to receive favorable tax treatment by deferring taxation until sale
- sulam 9y ago
  Thanks, you beat me to it!
deleted 9y ago
[deleted]

js2 9y ago

That seems correct: However, it is intended that statutory options are not considered nonqualified deferred compensation for purposes of the proposal. An exception is provided for that portion of a plan consisting of a transfer of property described in section 83 (other than stock options) or which consists of a trust to which section 402(b) applies. Page 209 of https://www.jct.gov/publications.html?func=download&id=5031&chk=5031&no_html=1 https://www.jct.gov/publications.html?func=download&id=5031&... But I'm not sure how this impacts ISOs with an 83(b) election.

sulam 9y ago
I think in an 83(b) you haven't had a gain, same as today, so there's nothing to tax.

hedora 9y ago

It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant. (Yes, this rule is terrible for planning, because you don’t know what fraction of your shares are ISOs until they vest). Today, ISO’s are commonly given to engineers at pre-IPO startups. Nothing says they have to go to execs. Those engineers end up holding them for years before they can exercise, so $100K is a small fraction of a normal Silicon Valley startup, when you divide it out. Many startups take 6-10 years to IPO these days. Source on $100K cap: stock plan admins at work, and also this article: http://help.capshare.com/knowledge-base/what-is-an-iso-100k-violation/ http://help.capshare.com/knowledge-base/what-is-an-iso-100k-... Please do not comment on technical nuances of the tax code you do not understand. Misunderstandings around this stuff bankrupts people all the time. (especially the type of people that hang out here!)

jalonso510 9y ago
"It is not the strike price or the exercise price. It is more-or-less the fair market value of the options when they vest, but if you need to compute your taxes, consult an accountant" This is not correct. The $100k threshold is calculated based on the fair market value of the option at the time of grant, which by definition is the exercise price. So you calculate how many shares you will vest in each year, multiplied by your exercise price, and as long as that is under $100k you are not over the limit and your option remains an ISO. If you're over, then the portion that exceeds $100k is treated as an NSO, but you can still get ISO treatment on the other part. I'm a startup lawyer and having worked with 100+ companies on their options, it's really not that common to get tripped up on this.
- sulam 9y ago
  I misspoke in using the term exercise value. However (and you’re a lawyer so I’m going to believe you here) everything I’ve read or can make sense of says it is the value at time of grant that the cap applies to, not some fluctuating fair market value at time of vest. Is that correct?

loeg 9y ago

Also — I don't see any problem with forcing companies to compensate employees in cash instead of employer equity. Especially for publicly traded companies, employees can go ahead, turn around and plow that cash into company stock if they want to. (RSUs are just cash in the form of stock anyway.)

sk5t 9y ago
The issue is that the companies that most depend on options/SARs/etc. to get off the ground do not have the cashflow. Otherwise it would not even be in their interests to grant equity.
- loeg 9y ago
  Again, I don't see that as a problem. Instead of paying their employees in cash and dreams, they're forced to just pay in cash. If employees are less keen on the same amount of cash without the dream, too bad for companies too marginal to pay a prevailing wage.
sulam 9y ago
>RSUs are just cash in the form of stock anyway. That’s an interesting point. They are and they aren’t. Cash as in actual dolla dolla bills they are not. Cash in terms of GAAP liabilities they are. But “stock-based compensation” is generally the largest part of what public tech companies exclude when they report non-GAAP earnings. And the lion’s share of those will be RSUs. Why do companies think this is a reasonable way to report? (Other than simply trying to look better for non-experts who don’t know how this stuff works.) The most obvious reason from my perspective is that this is a variable cost that is already baked into the model. The variable part is obvious — if I make a promise to give you 300 shares the value side is going to change over time. If our earnings are crappy and everyone sells the stock (to who?!) then the value of your compensation has just dropped. The cost side is also weird — these shares aren’t bought on the open market at time of vest, they are in employee pools that are set aside ahead of time (in fact my understanding is that the usual terms of an RSU require the stock to be set aside at time of grant). So theoretically they should cost whatever the fair market value is at the time the pool was created. Either way they aren’t cash that left the company’s bank account and went to the employee, like regular compensation. Accounting is hard!

zwily 9y ago

Thanks for this. I suspect that for most of the situations where people were (mistakenly) freaking out about their ISOs being taxed on vest, they will actually be much better off given the removal of AMT in the bill.

robbomacrae 9y ago
AMT started off with reasonable intentions but 47 years later it ended up effecting way more people than intended due to inflation. I feel like the $100k limit will end up doing the same.
tomc1985 9y ago
How does it apply to options already vested?

econner 9y ago

The problem though is that if you have ISOs they usually have to be exercised within 90 days of departure from a company. Some companies are extending that deadline to 7 years, but the IRS disqualifies ISOs 90 days after departure so they have to convert to NSOs. So this would prevent companies from providing an option extension.

hkmurakami 9y ago
I thought about this, and if the taxation trigger is "tax upon vesting", and the vesting is done when the options are ISOs, I would think that it is possible that this legislation is worded in a way so that an ISO -> NQO conversion does not trigger a tax event.
- Bartweiss 9y ago
  Is it clear what tax impact the conversion has? Arguably that's the moment when you "vest NSO options", but then the entire tax blow would drop upon leaving the company, which would be particularly bizarre. (Is the proposed law even clear about how this would work?)

KerrickStaley 9y ago

Can you link to the Fenwick analysis that this is based on?

deleted 9y ago

[deleted]

godzillabrennus 9y ago

As a consultant who gives price breaks to early stage startups by taking options on a NQSO agreement this is often the only way to avoid getting taxed. This will suck.