In some circumstances, stock options may seem like a win-win for startups: they provide new companies with a means of compensating their employees during the company’s low-revenue, early days; meanwhile, they may incentivize employees to take calculated career risks and work hard in hopes of a big payday later on. But one of the downsides of this arrangement is periodic burdensome tax liabilities on employees with options.
Under the current regime, once the employee’s stock options vest, he or she has a set period of time to exercise the option before it expires, and the employee immediately incurs income and social security taxes on the difference between the amount paid for the stock and its fair market value. This may pose a problem for startup employees who, unlike employees with options at publicly traded companies, do not have a ready-made market on which to sell some or all of their stock to pay these taxes. And they are usually unable liquidate some their shares to cover the tax bill. Oftentimes employees must either pay the tax out of pocket, or let the option expire to avoid the incurring the tax.
But new legislation aims to help employees take advantage of their stock options without incurring these burdensome obligations. The “Empowering Employees through Stock Ownership Act” (the “Act”), introduced as identical bills in the House and the Senate, would allow private company employees (under certain conditions) to defer their taxes on the exercise of non-qualified stock options. Rather than having to pay the taxes immediately, the employees would have up to seven years in most cases.
For employees, the Act could provide some much-needed breathing room from the stifling tax treatment of an otherwise favorable benefit.