
San Francisco Wants to Tax Your Stock Options – All of Them - emmanuelory
http://techcrunch.com/2011/02/18/san-francisco-wants-to-tax-your-stock-options-all-of-them/
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gojomo
I started to write about how Lacy's scenario, whereby Twitter (or its
employees) could somehow wind up owing $75MM on $5B in valuation-appreciation,
is mightily confused. 'Payroll expenses', after all, are counted in the year
equity/options are granted, based on the value/discount at that time. That's
reasonably like the way other compensation can be valued. After that point,
the interest is transferred to the employee, who later will pay capital gains
income taxes, _when_ those gains are recognized (or in some AMT scenarios).

It would be unprecedented, as far as I know, for a _company_ to be liable for
taxes on _the employee's_ on-paper-only gains, occurring some arbitrary time
later at option-exercise.

And yet: that seems to be what Section 902.1(b) says.

The company is on the hook for payroll taxes on the employee's share
appreciation, at the moment of option-exercise. Even if the shares are not
even sold for any recognized capital gain. Even if the person is no longer a
company employee or resident of San Francisco. Even though the company may
have already paid taxes on the then-current grant-value in an earlier year.

I not a tax lawyer but on the surface, this seems insane.

~~~
cosmicray
> It would be unprecedented, as far as I know, for a company to be liable for
> taxes on the employee's on-paper-only gains, occurring some arbitrary time
> later at option-exercise.

The questions is ... would the same taxation be applicable in the reverse
direction ? Say SF taxed you on big paper gains last year, your startup
crashed and burned this year. Can you get a big refund ?

If not, then it would suggest a new avenue for arbitrage: trading stock in
dead startups merely to offset gains in still functioning entities.

~~~
gojomo
As this provision only triggers on exercise, not sale, there seems no way for
an ultimate loss to balance out for the company. And since an employee would
never exercise an underwater option, there's never a 'negative' payroll
expense flowing to the company.

Intentionally overpaying for dead/dying/underwater company options/equity, to
create offsetting losses, would save less in gains taxes than the new losses
taken on. And, there's no indication a company could deduct investment losses
elsewhere against this particular purported 'payroll expense'.

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jonburs
"The tax rate? 1.5%. And remember that neither the federal government, nor
California, tax gains on most employee stock options at all."

Absolutely false. When exercised non-qualified stock options (the most common
kind) are taxed as income (at the federal level) based on the difference
between the strike price and the current fair-market value. This is true even
when the options are in a non-public company. Every time I've exercised
options I've had to pay tax witholding, and the income and witholding were
reported on the relevant W2s.

I don't know how most states treat options; I live in one (WA) that doesn't
have an income tax.

~~~
pkghost
The article discusses payroll tax, which employers pay, not income tax, which
employees pay.

~~~
dedward
This is where it gets confusing in Canada, and people get bitten. It DOES work
this way in Canada, - when you exercise an employee stock option and convert
it to stock, you have an immediate tax obligation based on the difference
between your option value and the current market value (specified somehow, I
forget). That is considered income, and you are liable for it. If it's going
to be considered income, then the employer SHOULD pay the witholding tax just
as with regular income, because we're taxed as if it's regular income. I wish
employers had done this - mine chose not to (they weren't required to) - and
the burden was on me to know that it would be considered income nad I had to
pay it. (So yes, that means when I exercised it I sold it all at the same
moment, put half away in savings for tax time, and did whatever with the
rest.)

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EGreg
If they do it, the situation will be simple:

1) San Francisco enforces taxes

2) San Francisco gets a lot of bad press.

3) Companies start moving to other cities.

4) San Francisco has less startups in the future.

Look at Texas and the taxes they just imposed on Amazon. Did it help them?

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viggity
There should be some sort of state law that preempts municipalities from
pulling this bullshit. In SF, who gets to make up these municipal tax codes?
The city council? How many people need to make up their mind one way or the
other to levy what could be a gigantic tax? 10?

Letting such a small group of people tax have such a gigantic amount of power
is dangerous.

~~~
viggity
For a city of 815K, they have 11 people on their board of supervisors
(<http://www.sfbos.org/>). Does that mean they only need 6 of them to create
new taxes?

~~~
rdouble
No, the residents of San Francisco vote on the taxes.

~~~
viggity
then they'll reap what they sow as the big startups leave for palo alto

~~~
rdouble
Big startups don't move to Palo Alto as there is not enough office space. They
might move to Brisbane, though.

~~~
tesseract
Speaking of which I thought I read an article recently about the city of SF
attempting to negotiate with Twitter to get them to stay in town. If SF is
trying to encourage tech startups to stay, this tax seems more than a bit
counterproductive to the cause.

~~~
bgentry
The linked article discusses these negotiations at length.

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fleitz
I'm sure there are plenty of other cities who would welcome those jobs. After
all part of social responsibility is to look after the needy. San Fransisco
and the parasites that feed off the income tax of productive individuals
should start considering the high tech job needs of other cities, and other
areas with low tax rates.

~~~
schwabacher
I find this offensive.. I don't live in San Francisco and I can't speak to the
specific situation there, but people are not parasites.

And if you are categorizing things into 'productive' and 'non productive',
what kind of net benefit to society do you think Zynga produces?

~~~
fleitz
I find parasites offensive as well. Many definitions of parasite specifically
cite _people_ as the object being described.

<http://dictionary.reference.com/browse/parasite>

a person who receives support, advantage, or the like, from another or others
without giving any useful or proper return, as one who lives on the
hospitality of others.

(in ancient Greece) a person who received free meals in return for amusing or
impudent conversation, flattering remarks, etc.

Perhaps you are right as the definition of parasite in regards to people
generally indicates living off others by their consent. Rather than living off
others by threat or use of force.

~~~
schwabacher
I assume you are deliberately misunderstanding what I found offensive?

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dedward
in Canada, Employee stock options, when exercised, are considered income for
that year, and are supposed to be reported by your employer as such, and are
taxed as such.

Note this isn't a capital gains tax - and the bad part is there isn't
necessarily any income - the value you are taxed t is the fair market value or
closing market value, I forget, but it's a simple calculation, based on the
difference between the value of the strike price on your options compared to
the market. So if you have 10,000 shares at $10, and the market is at $10 or
less, and you were vested, you could exercise all those shares, converting
them to stock, and there would be no additional income tax. If the stock is
now at $20, the tax man would view your conversion of those options into stock
as a straighht up $20,000 gain from employment. Generally the move in this
situation is to have your broker validate the paperwork with the company, and
then ONLY exercise stock at the same moment you are ready to sell it - the
broker will handle the whole transaction for you, even short the stock and
then use yours to make up for it, whatever. This minimizes your exposure.

Employee Stock Options by thesmselves (in Canada) carry no liability. You can
ignore them if you like. You also have the option of, with some paperwork,
delaying that tax burden until you actually SELL the stock. IF you did that,
you'd still have the same $20k added to your income in the year you sold (you
deferred, right?). You still pay capital gains on the difference between the
market price on the day you bought (not the strike price on the options, which
was what you actually paid) and the selling price - but that's taxed as
capital gains. This situation can protect you if you plan to never sell or the
company goes bankrupt, if you keep your paperwork and ducks in a row - though
there is another hitch if you plan to work and live outside the country
(become non-resident for tax purposes) - in this case all kinds of tax
obligations come smacking down on you as you are leaving hte jurisdiction.
(THe upside, of course, is canadians are only taxed based on residency, not
citizenship - so if we live and work abroad for real, not just a short job,
but actually leave and don't have any fixed plans to come back, we don't pay
or even report income to teh tax authorities in canada)

 _Disclaimer: My knowledge is a decade old - I suspect some of this may have
changed. There was quite a bit of uproar, not about the tax itself, but the
specifics that it was immediately considered employment income and that you
had an immediate tax obligation. I think_ something* has changed, not sure
what.

~~~
grimlck
I respect you for acknowledging that your information is out of date. As far
as how it works today...

In Canada, the gain from stock options is subject to just a 50% income
inclusion. So, in your example, if you get a $20000 gain from the stock
options, you would only be increasing your taxable income by $10000. In other
words, if your marginal tax rate is 36%, the effective tax rate of the option
gain is 18%. This is the same income inclusion rate as a capital gain, but it
is not considered to be a taxable gain, so you cannot use it to offset capital
losses.

The deferral ability you mentioned (delaying tax until you sold the stock) was
eliminated in the 2010 Canadian Federal budget. (Relief was also made
available for people who used this deferral option in the past, and have had a
stock price decline since the deferral)

Disclaimer: I am not an accountant.

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joelmichael
I would probably pay a bit more than 1.5% to stay in San Francisco. That
amount isn't worth it to give up on your metropolitan lifestyle and appeal to
employees.

~~~
e40
So you think the $75M out of the $100M raised is a fair chunk to give to SF?

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johnolagues
Any creative holder of employee stock options can change their gains into tax
free income and not worry about city, state or Fed tax..

John Olagues olagues@gmail.com

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patrickgzill
American Taxation 101: If you have money or might make some in the future,
they want some of it.

~~~
haribilalic
I believe this is the basic principle of taxation, yes.

~~~
patrickgzill
Actually it isn't - my joke-y comment was to get people to think ... Thomas
Jefferson and many of the other Founding Fathers wrote extensively on the
subject; as did many others who were not American...including Bastiat, Gesell,
etc.

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anonymous246
This is the sort of law that I thought only existed in sclerotic zero-sum
societies: stupid laws that exist to be selectively applied to harass people.
Either repeal it or enforce it. Reminds me of the USSR.

Note, just like this "socialist" law, similar "conservative" laws abound. I
dislike them too.

~~~
wladimir
Indeed, authoritarian regimes like arbitrary laws that they can enforce
selectively. As long as people fly under the radar, the laws won't be
enforced. This makes sure that there will be no protests, because "who cares
about laws that aren't enforced anyway?".

On the other hand, police officers (and higher authorities) can use these to
lock up people that they don't like, or didn't pay their bribes. It will also
mark the accused a social stigma, even though everyone and their brother
violates that law, but people arrested for it are "criminals": Very effective
in locking someone out of positions of power.

This can concern copyright laws, traffic laws, tax laws, laws with respect to
sexual conduct, and so on... they've all been used in this way.

