U.S. tax break could push startups to share the wealth

[December 22, 2017]  By Heather Somerville

SAN FRANCISCO (Reuters) - Startup companies came away with a significant victory in the U.S. tax overhaul -- a chance to defer the often-onerous tax bill that is attached to company stock options.

To get the tax break, companies must provide stock options to at least 80 percent of their workforce, a requirement that could prompt startups to spread the option wealth more widely.

Employees with options are commonly required to exercise them within 10 years, or within three months of leaving a startup. The gains on those shares is taxed as income, and the tax bill can easily climb to hundreds of thousands of dollars for early employees at a successful startup, say tax experts. The value of a stock option package can be worth about 10 times an employee's salary, said Mary Russell, an attorney who counsels individuals on their startup equity offers.

But employees face a big challenge when the startup is not yet public and they cannot sell the shares for cash to pay the taxes.

Now, private-company employees will be able to defer those taxes for up to five years. Certain top executives and high earners will not qualify.

"I feel a sense of relief that I have more time to figure things out," said Jamil Poonja, head of public policy and communications at San Francisco startup Stride Health, who has part of his compensation in options.

But the provision's fairly restrictive rules mandate that companies must provide stock options to at least 80 percent of their employees to be eligible for the new tax deferral.

"That might change the way people allocate equity," said Kate Mitchell, co-founder of Scale Venture Partners. "But there is value in distributing it across the company."

A woman looks at her smartphone as she attends the NYC Startup Job Fair in New York, April 11, 2014. The fair expects to connect more than 1,000 job seekers with dozens of New York-based startup companies. REUTERS/Carlo Allegri

Startups vary in how they grant stock options to employees. The common practice among venture-backed companies is to carve out 20 percent of their total equity to distribute to employees, said Anand Sanwal, CEO of data firm CB Insights, which tracks startups.

The new tax provision responds to a problem created by the shifting investment dynamics in Silicon Valley. In the dot-com era, companies went public after an average of four years. Today, the average age is 11. That means employees have much of their wealth tied up in options that cannot be sold on the public stock markets for more than a decade.

Many resort to taking out loans or, in more extreme cases, abandoning their shares, said attorneys and founders.

"Sometimes people don't or can't or won't write that big of a check," said Jason van den Brand, co-founder of home refinance startup Lenda. "They're like 'This is going to cost me $50,000, where am I going to get that?'"

(Reporting by Heather Somerville. Editing by Jonathan Weber and Lisa Shumaker)

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