
Proposed Tax Reform Stands to Impact Equity and Performance-Based Compensation - muzz
https://www.fenwick.com/publications/pages/proposed-tax-reform-bill-stands-to-significantly-impact-equity-and-performance-based-compensation.aspx
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hkmurakami
Overall I think average comp full time employees at eaely stage startups will
be a big beneficiary. They won't hit the exercise threshold, AMT will be gone,
and ISO tax benefits and 409A valuation will remain.

One problem I see is that the extended exercises that are popular these days
convert from ISO to NQOs, so I wonder what that treatment will be like.

Contractors lose some flexibility over NQOs, but imho they were unlikely to
have extended exercise periods anyways so I think the impact is not as large
as communicated?

Executive especially at late stage companies lose out because of the exercise
cap, but they're doing extremely well anyways so whatever.

Employees at late stage companies might be in a bind here. They probably won't
hit the ISO exercise cap (BC the value should be 409A based target than
preferred price based) but the currently popular method of giving out RSUs
that don't officially "vest" until the company goes public (or the employee
leaves, I imagine) might get affected, and that's potentially significant.

~~~
perfectstorm
> AMT will be gone

Trump is doing this to help himself. I read somewhere that he got hit pretty
bad on AMT recently.

~~~
matt4077
Let's avoid making the same mistakes the right always makes, namely assuming
the worst of people, and always assuming financial motives for peoples'
actions.

Trump reducing the AMT for himself seems somewhat unlikely, because:

= The plan(s) are written by the House and Senate, not the administration.

\- he doesn't seem to have given any relevant input to these tax plans except
asking for lower corporate tax rate (which he hot only partially)

\- AMT has so many opponents among Republican donors, Trump just doesn't need
to get involved.

\- Trump was hit by AMT because he had large losses that are deductible over a
certain number of years. Don't remember the number, but I seem to remember
they have run out by now. He'd need a new bankruptcy to keep going. And no,
morally doesn't count.

\- I'm not sure if he is still motivated by money as much as he used to be. It
seems to always have been a plot to get recognition by Manhattan's elites, and
therefore would have been eclipsed by his _other_ failed attempt, namely
politics.

~~~
refurb
_Let 's avoid making the same mistakes the right always makes, namely assuming
the worst of people_

This made me chuckle. You're basically telling people to not do what you just
did.

------
loeg
At least at my employer, the deferred compensation plan is only offered to
high-level management employees ("Director" and above). So this doesn't seem
to be a great loss for the average engineer.

If other people who are individual contributors, or even low level managers,
have access to an employer deferred compensation plan (different from my
experience), I would love to hear about it.

(As a highly paid engineer, I would totally make use of this deferred
compensation scheme to lower my tax burden by smoothing out my income, if I
could. But I've never been able to.)

~~~
seattle_spring
I've literally never heard of a tech company _not_ offering deferred
compensation (either stock options or RSUs).

~~~
loeg
RSUs aren't elective deferred compensation. They're just income at the time of
vest. ISOs are a little weirder. Nevertheless, neither is what I'm talking
about.

Traditional 401(k)s are a type of _qualified_ deferred compensation plan and
are slightly closer to what I have in mind.

The type of plan I am referring to is a _non-qualified_ deferred compensation
plan. Unlike 401(k)s, they are not protected from the sponsoring organization
(or the sponsoring organization's creditors) accessing the funds, for example,
in bankruptcy. On the other hand, they can smooth out income taxes, and are
not subject to the same contribution caps as 401(k) plans. Like in a 401(k),
these non-qualified plans allow you to control how funds are invested while
they are deferred. Unlike 401(k)s, you choose when they will pay distributions
in advance.

Here's a little bit more about this kind of plan, from Fidelity:
[https://www.fidelity.com/viewpoints/retirement/nqdc](https://www.fidelity.com/viewpoints/retirement/nqdc)

> Most companies provide NQDC plans as an executive retirement benefit,
> because 401(k) plans often are inadequate for high earners

------
glymor
> Similarly, awards with vesting triggers based on exit events such as an
> initial public offering or change-in-control would be taxable on grant
> unless they require the recipient to be employed through the liquidity date

Double trigger RSUs are popular in late stage unicorns where the exercise
price for ISOs have already hit a high level but the stock isn't liquid enough
to sell to cover the tax as they vest.

A lot of people might be affected, I wonder if existing grants are
grandfathered in?

~~~
clairity
there is a section in the document called "Grandfathering of Compensation
Earned Prior to 2018" =)

~~~
weaksauce
These grandfather clauses irk me... if the policy is not good enough to stand
on its own then it should not be policy.

~~~
wpietri
Not at all. It's a recognition that the people who made long-term arrangements
under the old law shouldn't be punished for that. The safer people feel making
commitments, the more we can pursue things that take time to pay off, which
has broad societal benefits. And in practice, laws are much harder to change
if you piss off a lot of people who didn't do anything wrong but now suddenly
stand to lose big.

As an example, take the mortgage interest tax credit. Personally, I strongly
believe it should go away; if the government is going to subsidize housing, it
shouldn't spend most of that money on the already well off. But I think it
would be wrong to screw all the homeowners who bought a house expecting the
credit. We'd see a wave of disruption (short sales, foreclosures, people
suddenly barely scraping by) that benefits nobody. So I'm fine with
grandfathering existing mortgages and gradually phasing out the credit.

~~~
jonahhorowitz
It would be totally reasonable to phase out the mortgage interest deduction
over ~10 years, giving people time to plan and decide how they wanted to
handle it. The cap is currently $1M, let's reduce it by $100k/yr. (or $50k/yr
over 20 years)

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paulsutter
Since most ISOs permit early-exercise, isn't this a moot point? (if a given
ISO permits exercise upon issue, since the value of a newly issued ISO must be
zero, then this $100K cap is not an issue?)

> In particular, under the current tax rules, the total aggregate fair value
> of ISOs that become exercisable for an individual employee for the first
> time within a calendar year may not exceed $100,000. ISOs that fail to
> comply with this provision are treated as non-qualified stock options.
> Companies with higher valuations would easily hit this threshold for
> executives and highly-paid employees and therefore would have limited
> reprieve from 409B.

EDIT: it says “become exercisable”, which is completely separate from actual
exercise

~~~
fossuser
A lot of larger private companies don't allow early exercise (and even if they
did the strike price is often pretty high anyway).

The "become exercisable" language is ambiguous to me.

If you have ISOs that became exercisable in one year that at the time were
less than 100k, but you didn't exercise them and they're now worth more than
that they still remain ISOs right?

Would you still hit the 100k limit when you tried to exercise them if AMT is
repealed or could you exercise all of them and delay the tax burden until you
sell them?

If that's the case getting rid of AMT would be a big deal for people in
private companies to actually be able to exercise their equity without paying
a massive amount of taxes for something they can't liquidate easily.

~~~
paulsutter
I would never work for a company that doesn't allow early exercise. Whether or
not you plan to do it, you have to wonder about the attitude of those in
charge if they don't allow early exercise.

~~~
jdavis703
Allowing early exercise is a legal and accounting headache. Many small
startups have a hard time even getting stock option agreements to employees.
When you're new, small, and possibly don't even have an HR person you can't
really spend time on frivolous things like early exercise.

~~~
fossuser
I also thought that early exercise at a certain point could force a company to
go public, but it's possible I'm mixing up laws.

I think it had to do with how many share holders you could have, but I think
that law also changed to not include employees as share holders.

~~~
jdavis703
The JOBS Act changed this rule [0]:

"In order to mandate becoming an SEC reporting company, you now would have to
have $10 million in assets and at least 2000 shareholders or 500 shareholders
who are not accredited investors. Stock issued pursuant to an employee
compensation plan would not be counted for this purpose."

0: [https://investmentbank.com/summary-of-jobs-bill-and-
update/](https://investmentbank.com/summary-of-jobs-bill-and-update/)

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shmerl
_> 409B does not appear to impact the taxation of incentive stock options
(ISOs), which in conjunction with the repeal of the alternative minimum tax,
would make ISOs more valuable_

So AMT is being repealed now?

~~~
ajross
Yes, which is sort of a shame. Frankly if you were serious about simplifying
the tax code and reducing unfairness and asymmetry, you'd __keep __the AMT and
throw out the existing income tax.

But whatever: the AMT is an issue for upper middle class taxpayers, and
particularly ones (like tech employees, and most particularly startup
employees) who see lots of their income in big chunks like stock grants and
option exercises. Helping these people is sort of dumb, as they (we) are
hardly hurting to begin with. But it won't break the economy either.

Honestly, the Senate plan is... not at all insane (and the House plan only
slightly insane). These are relatively modest tax cut bills arriving at a time
where the economy is growing and deficits are shrinking, which is exactly
where you'd want them. [ _Edit, hoo boy did this statement the trigger the
economics folks. This isn 't a growth point, the metric here, which I thought
I'd made clear, is "when they are least likely to mess things up". Passing
this bill won't break the bank or make progressive reforms in other areas more
difficult in the near term._]

After the last year... it's like a breath of fresh air. I still don't think
this is Good Policy per se, but the very fact that our government isn't
actively trying to make things worse is hopeful.

~~~
CalChris
> These are relatively modest tax cut bills arriving at a time where the
> economy is growing and deficits are shrinking, which is exactly where you'd
> want them.

So you want to cut taxes and increase deficits during growth times? This is,
of course, not just different but exactly the opposite of Keynesianism. What
is it that you plan to do during recessions? Cut spending and increase taxes
to close your deficit?

This is insanity.

~~~
briandear
Keynesian economics is insanity. Disproven by Milton Friedman and others.

~~~
CalChris
Milton Friedman was a _monetarist_ which is a belief in controlling the supply
of money. That's a different instrument but actually quite similar to Keynes:
they are both feedback control mechanisms. That said, monetarism is most
definitely NOT _cut taxes and increase spending in good times_. Keynes and
Friedman would both call that insanity.

~~~
fjsolwmv
Taxes on fiat currency are away to distribute expenses, not a way to raise
funds. A fiat currency government can print money whenever it wants, which is
taxation via inflation. (For more, see: Modern Monetsr Theory.)

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PrgsvThgt
Personally happy to see that the new tax code appears to reduce the inequality
between staff and executives, with regard to compensation and taxation. I'm a
strong advocate for leveling the playing field for EVERYONE; because it
eliminates (or reduces to the extent possible) the ability to negotiate these
special options for "deferred" compensation.... for which the vast majority of
us will never qualify.

~~~
hedora
This doesn't do that at all. It punishes employees 100-1000 of late stage
startups with unknown, perhaps bankrupting retroactive taxes. The entire 409a
system was designed to protect exactly that group of employee after the dot-
com crash, and this undoes it.

Founders and execs likely will be fully vested before their options are worth
anything at all (figure 8 years from founding to IPO, 4 years to vest).

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banku_brougham
Tjis tax plan is not likely to pass. It has major stakeholders as active
opponents, and an impotant cadre of republican congress-people from coastal
states. There’s plenty of reporting on Politco or Washington Post that
outlines the difficult road ahead for this legislation.

~~~
hkmurakami
The GOP has high risk of losing control of one or both chambers of Congress in
2018 of they don't pass some kind of tax reform.

The contents are in flux but I'd happily wager on them passing _something_
they can point to

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s73ver_
Oh come on. The absolute last thing we need are more things making it harder
for people to keep the options they earned after leaving the company.

~~~
seattle_spring
You're right! Which is why getting rid of AMT will actually make it
significantly easier.

~~~
s73ver_
I was referring to this part: "Similarly, awards with vesting triggers based
on exit events such as an initial public offering or change-in-control would
be taxable on grant unless they require the recipient to be employed through
the liquidity date"

~~~
djrogers
In my experience those vesting triggers are much less common than a fixed
vesting schedule.

------
gwbas1c
Honestly, everyone's just trying to game the system. Someone figures out a way
to game the tax code, and then the laws get written to support those games.

Taxes are just too darn complicated! It takes far too long to figure out what
I legitimately owe! I shouldn't have to pay a professional or use a computer
to figure that out.

~~~
spaceseaman
> Taxes are just too darn complicated!

While I understand this sentiment, I feel that a complicated tax code (or
legal code in general) is just where countries end up going as they become
larger and more important in the day-to-day lives of its citizens. All the
various financial situations in this country are incredibly complicated.

Perhaps we should take a similar route as public defenders (not in practice
but in theory, public defenders are horribly under-funded at the moment). The
government could provide a tax management program for the general public that
does the basics for you. Basically if you qualify for a 1040-EZ you can just
use some IRS front-end system. If you have a more complicated situation, then
accountants are always available.

I'm frankly disappointed our governments have not done more with the Internet.

~~~
gwbas1c
The problem is that TurboTax lobbies against this. Basically, they benefit
from our current system. That's why proposal for things like the IRS filling
out your taxes for you are illegal.

Really, what should happen is that the IRS mails you your taxes already filled
out, you check for errors and fill in the things that aren't reported, and
mail it back. This would kill TurboTax's business, so they lobby against it.

~~~
craftyguy
So the solution isn't to nerf the existing tax code, but instead to elect
representatives that are actually looking out for their electorate instead of
companies like TurboTax.

