Comment by gojomo | Hacker News Reader

Comment by gojomo | Hacker News Reader

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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.

> 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.

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'.

Its a crazy idea, and I agree with the author that implementing it would be suicide for San Francisco. That being said, the existing system of 'employee stock purchase programs' or ESPPs where employees are required to tell the company when they sell them (even if they are no longer with the company) if they hold them for less than 2 years, gives us a hint of how San Francisco might try to implement this.

Company X issues a stock option and records the grant, employee exercises the option and Company X is required to pay 1.5% of the gain defined as the difference between the exercise price and the fair market price at the time of exercising) as tax when its exercised. This 'paper' gain is subject to the same taxes it would seem as AMT which has a similar "your liable for the tax even if you didn't get the gain" pain for tech employees.

Restricted stock would no doubt be taxed at issue time, I would be surprised if it wasn't already but I'm not an accountant.

Having researched Non-Qualified Stock Options (NQSOs) a bit more since writing the above, I've learned that for NQSOs, companies are expected to do tax withholding at the time of option exercise, even collecting money (beyond the exercise price) from the exerciser as necessary. This is in expectation of the exerciser's ordinary-income liability for the spread-at-exercise.

That's somewhat like the reasoning of the SF payroll law – though the tax/withholding is from the funds of, and for the liability of, the (possibly-former) employee, rather than the company itself. Still, the SF law is more analogous to current treatment of NQSOs than I'd realized, using the same spread that generates employee ordinary income tax as the basis for the company payroll tax.

So not quite as unprecedented and insane as I'd thought, though still a mess for startups compared to less-taxing jurisdictions.

Yes, every time I exercise NQSO, a paystub is sent to me and tax is withheld. I also get a paystub when exercising ISO, although no tax is withheld. It is actually more chore for me because I need to keep track of the gain and send estimated tax (I only do same day sale, the only sane option in my opinion). The article is very misleading to imply stock option is tax free. Techcrunch never grant her any stock option I figure.

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