I think it'd be useful if you'd explain to folks on HN the tax implications of exercising their options (or holding shares) of their company stock over a 5-10 year period as it increases in value but not in liquidity.
For example, someone with stock purchased at $0.01/share that has a new 409A common stock value of $1.00/share may have a substantial tax consequence, despite not having any actual liquidity. You can discuss this better than I can.
Stock options are a loaded question but I’ll discuss it in general terms.
There are two types of stock options. Qualified and Non-Qualified.
Qualified stock options are those given to employees. So, all of the first employee hires that get equity are essentially going to get qualified stock options because they are getting an incentive. These options are not included in your gross income, but you may have to pay taxes on the year you exercise them due to the Alternative Minimum Tax (this was meant to be a tax on the rich back in the 1970s but now its hitting everyone in the middle-class).
Non-qualified stock options are those that you get if you’re not an employee generally. This means that you’d have to include the value of stock options in your gross income. This is where Section 409a hits you. Section 409a has a bunch of requirements as to when you are allowed the options for example:
1. The employee’s leaves or separates from the company (if you're a key employee, then you need to wait 6 months later, before you can get the distribution of options.)
2. The employee has an unforeseeable emergency
3. The employee becomes disabled
4. The employee is dead
5. A fixed time or schedule specified under the plan
6. A change in ownership or effective control of the corporation, or a change in the ownership of a substantial portion of the assets of the corporation; or
In reality…
If you’re a startup and you’re giving options, there’s no way for the IRS to make you include these options in your income because they have no real value yet. The IRS requires income to be (1) accurately determinable and (2) reasonable assured. As we all know, options and common stock equity in startups is anything but determinable and assured. So realistically, this won’t make a difference initially. But, once you start getting traction and get valued from VCs, this will come back to bite you.
You could also choose to use a variety of valuation models. There's even a "startup model." The startup model is basically where the VC thats funding you will tell you what the valuation is lol.
Conclusion: Stock options are not part of gross income if your getting qualified stock options.
But, later on when you sell the stock or equity. It'll lead to capitals gains. By then, you'd probably of had the equity for over a year so they'd be long term capital gains, which are taxed at 15%.
sorry for the long post. its late and i'm probably babbling.
For example, someone with stock purchased at $0.01/share that has a new 409A common stock value of $1.00/share may have a substantial tax consequence, despite not having any actual liquidity. You can discuss this better than I can.