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I'm pretty sure they're including the taxes paid in the cost at exercise. You're correct - the strike price remains the same regadless of valuation, but you nee

I'm pretty sure they're including the taxes paid in the cost at exercise. You're correct - the strike price remains the same regadless of valuation, but you need to pay taxes on the gains of converting your cheap options to expensive stock.

deleted 6y ago
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mywittyname 6y ago
It's still confusing because the table contains "net tax obligations" which appears to be the taxes due if one were to liquidate the whole kit and caboodle at once. Instead, I think it needs a another column for additional gross income for purposes of tax liability in year of liquidation. As I understand it, when you exercise your options at $1.20, you must pay $100k to exercise, then you own taxes on the $20,000 in gains. When you exercise at $20, you must again pay $100,000 to exercise the options, and also pay taxes on the $1,900,000 in gains. And this fact is what causes early employees to walk away from so much money. There's a huge difference in viability of paying the tax bill on $20k of income vs. $1.9MM when the underlying assets are illiquid, and cannot be sold in part to cover the bill. Most people will be able to come up with another $6,000 or so to cover the taxes from an early liquidation. But it's substantially more difficult for most to come up with the $500,000 to cover the tax liability in the second case.
- deleted 6y ago
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- x86_64Ubuntu 6y ago
  >...and cannot be sold in part to cover the bill. Wait, so I can't exercise in July, get the money, and then pay the tax bill in February of the next year?
  - mywittyname 6y ago
    You can do that. But, if the company is still private, what you can't do is sell some of those shares that you just exercised in order to cover the tax bill. That's fine if you exercise at $1.20, since that $100,000 exercise only increases you taxable income by $20k. But when you fully exercise at $20, your taxable income for the year increases by $1.9MM. Most people in that situation can't afford to cover the taxes, so they walk away.
  - ska 6y ago
    Sure, but where did the money come from to pay the tax bill? Pre IPO you may find it difficult or impossible to sell any of the stock you now own, so you'll be out of pocket from somewhere else. This gets less and less practical for most people as the difference between strike price and value increases.
- jrdngonen 6y ago
  Hey there (co-founder of Compound here). You’re correct—timing of the payout is critical. We try to show that in the left-hand-side (today, 3, years, at IPO) but there’s more nuance to provide (e.g., are you applying AMT credits to your net outcome, is QSBS accounted for, etc.?). The example also includes that exercise and sale occur in separate years and that that sale is being realized as a long-term capital gain. The net tax liability we’re showing is the sum of taxes owed at exercised (AMT, which is often a credit) and taxes owed at sale (LTCG). We’re adding more specificity to this and future essays (as there are infinite permutations we can make).
- jbay808 6y ago
  It would be nice if you could just pay the government a percentage of the shares themselves as a tax, rather than a percentage of a guessed-at illiquid value. I'm sure the government would have a lot more paperwork to do holding onto all these random shares, but the benefits from simplifying and de-risking equity offers would outweigh that many times over.

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mywittyname 6y ago

It's still confusing because the table contains "net tax obligations" which appears to be the taxes due if one were to liquidate the whole kit and caboodle at once. Instead, I think it needs a another column for additional gross income for purposes of tax liability in year of liquidation. As I understand it, when you exercise your options at $1.20, you must pay $100k to exercise, then you own taxes on the $20,000 in gains. When you exercise at $20, you must again pay $100,000 to exercise the options, and also pay taxes on the $1,900,000 in gains. And this fact is what causes early employees to walk away from so much money. There's a huge difference in viability of paying the tax bill on $20k of income vs. $1.9MM when the underlying assets are illiquid, and cannot be sold in part to cover the bill. Most people will be able to come up with another $6,000 or so to cover the taxes from an early liquidation. But it's substantially more difficult for most to come up with the $500,000 to cover the tax liability in the second case.

deleted 6y ago
[deleted]
x86_64Ubuntu 6y ago
>...and cannot be sold in part to cover the bill. Wait, so I can't exercise in July, get the money, and then pay the tax bill in February of the next year?
- mywittyname 6y ago
  You can do that. But, if the company is still private, what you can't do is sell some of those shares that you just exercised in order to cover the tax bill. That's fine if you exercise at $1.20, since that $100,000 exercise only increases you taxable income by $20k. But when you fully exercise at $20, your taxable income for the year increases by $1.9MM. Most people in that situation can't afford to cover the taxes, so they walk away.
- ska 6y ago
  Sure, but where did the money come from to pay the tax bill? Pre IPO you may find it difficult or impossible to sell any of the stock you now own, so you'll be out of pocket from somewhere else. This gets less and less practical for most people as the difference between strike price and value increases.
jrdngonen 6y ago
Hey there (co-founder of Compound here). You’re correct—timing of the payout is critical. We try to show that in the left-hand-side (today, 3, years, at IPO) but there’s more nuance to provide (e.g., are you applying AMT credits to your net outcome, is QSBS accounted for, etc.?). The example also includes that exercise and sale occur in separate years and that that sale is being realized as a long-term capital gain. The net tax liability we’re showing is the sum of taxes owed at exercised (AMT, which is often a credit) and taxes owed at sale (LTCG). We’re adding more specificity to this and future essays (as there are infinite permutations we can make).
jbay808 6y ago
It would be nice if you could just pay the government a percentage of the shares themselves as a tax, rather than a percentage of a guessed-at illiquid value. I'm sure the government would have a lot more paperwork to do holding onto all these random shares, but the benefits from simplifying and de-risking equity offers would outweigh that many times over.