Why The Senate's Plan To Tax Employee Options At Vesting Is Bad For Startups

Startups are the envy of the world for how innovative and fast moving they can be. However, they often lack the amount of cash in the bank required to pay employees a salary that is competitive with the top tech companies such as Google, Facebook, Amazon, etc. To compensate for this, they give their employees an equity ownership in the company. Typically that equity vests monthly or quarterly over the span of four years. Here is a quick primer for anyone that wants to get brought up to speed on how "Startup Equity & Vesting" works. 

When an employee is given stock options, those options are illiquid. Meaning they can not be sold or transferred for money until the company has a liquidable event (e.g., an exit such as an acquisition or going public). So when employees receive options they usually have to wait years before being able to turn them into cash.

At this moment there are new Tax Reform plans proposed in both the House of Representatives and the Senate. The current proposal in the Senate plans to tax employee stock options at the moment of vesting, instead of when they are exercised, as is currently done.  The House of Representatives has already removed this provision from their proposal.

What is the tangible effect?  If passed, startup employees would be forced to pay taxes on these equity options, regardless of any realization of actual value.  

As Fred Wilson said, "Taxing equity compensation upon vesting makes no sense. If this provision becomes law, startup and growth tech companies will not be able to offer equity compensation to their employees. We will see equity compensation replaced with cash compensation and the ability to share in the wealth creation at your employer will be taken away."

Passing this law will make it extremely difficult for startups to compete with bigger corporations for high-quality talent. I am personally signing on to a letter addressed to Sen. Orrin Hatch, Chair of the Senate Finance Committee, to oppose the proposed new plan and ask that Section III(H)(1) be removed from the Senate bill. If you would like to speak up as well (with your local representative), you can find your senators here and your representative here, along with the phone number to their office.