Joining an early-stage startup is risky: toiling for long hours at below market rates for a company that has a minuscule chance of hitting it big. To lure talented employees away from public companies and comfortable jobs, startup founders often have to dole out stock options. These options give early employees a chance to buy stock at an early (low) price in the hopes that the stock will gain value in the future. The options typically “vest,” or transfer ownership, over the course of years.
The US Senate’s Tax Cuts And Jobs Act bill in the Senate would tax those options as soon as they are transferred to the employee or founder. Today, options are taxed when they are exercised (or cashed out). The proposal unveiled last week calls for stock options to be taxed upon vesting, a crucial distinction.
Early employees or founders would have to pay taxes even if they don’t sell their stock. Since vesting typically occurs many years before a stock is sold (or even can be sold because startups restrict stock sales before a company goes public), that tax bill could be crushing. As one petition states, startup founders and employees would shoulder an enormous tax burden if their company was successful or not (despite receiving no income in many cases).
The idea landed like a bomb in the Silicon Valley community this week. One compensation lawyer called it the equivalent of taxing a “lottery ticket.” The National Venture Capital Association said in a statement the draft legislation “would cause great harm to the ecosystem,” urging that legislators “not raise taxes on investment in entrepreneurial activity.” Fred Wilson of Union Square Ventures said “taxing equity compensation upon vesting makes no sense,” while PayPal co-founder Max Levchin called the potential impact on Silicon Valley “devastating.”
Given the state of play with the legislation, anything is possible. The wording of the proposal has shifted as the Senate and House have drafted their own legislation with early House versions removing the requirement that all stock be taxed upon vesting. The House’s version taxes shareholders when shares are exercised through an IPO, acquisition or other liquidity event.