I can see wanting to tax people on paper gains as a way of closing loopholes -- but if the paper gain evaporates we should let them off the hook.
This would solve a lot of other tax issues relating to transfers of illiquid equity. Consider the estate tax - a guy owns a business the IRS values at $10M and dies. The kids don't have $1.75M sitting around in cash (35% of $10MM-$5MM exclusion amount) so they are forced to liquidate the business. Instead, wouldn't it be better to allow the business to continue running, but pay the IRS 17.5% of dividends/pass through income?
[edit: said profit, meant dividends. Thanks orijing.]
Like any 17.5% shareholder, they are entitled to 17.5% of the profits (ignoring details like profits not immediately distributed to shareholders).
I see the following reasons (atleast), the proposed solution is a no-go.
a. 17.5% cash >> 17.5% shares of a business, which is struggling to pay 17.5% cash.
b. what happens if the business goes under and IRS owns 100% shares of the business?
c. What happens if all IRS get in payment is shares. How the country economy is supposed to run? (with foreign trade etc.)
Today, they don't have to. Their incentive is exactly the opposite: overvalue things to get more tax out of it.
I think we can all agree the best thing is to take away ability to tax phantom money from IRS. Next best thing is to setup the rules so that IRS is on the hook if they overvalue phantom money.
If 17.5% of a business is worth less than $1.75M then 100% of the business is worth less than $10M. Thus the tax bill should be lower than $1.75M.
what happens if the business goes under and IRS owns 100% shares of the business?
Then the IRS's initial valuation of $10M was inaccurate. Why should the business owner pay for mistakes made by the IRS?
No, The point I was trying to make was that shares of a struggling business is always less in value (due to inherit risk), as compared to hard cash (Which is equal, irrespective of its genesis.)
Then the IRS's initial valuation of $10M was inaccurate. Why should the business owner pay for mistakes made by the IRS?
No reason. Similarly IRS has no reason to take the investment risks (as its interested in collecting revenues, not funding companies).
I just gave a potential risk of scenario, where the business is unable to pay to the IRS money (due to lack of enough cashflow in the business), but still getaway with it. (When it eventually does get bust, but at the cost of IRS/government/Taxpayers, not the owners.)
You gave a potential risk scenario where the IRS declares a company is worth a lot, but in reality it is worth very little. You then advocated that a taxpayer (the business owner) should suffer for this mistake by paying cash (some percentage of an incorrect valuation) instead of equity.
But that's silly - if the business is about to go belly up (i.e., it's really worthless), the taxpayer should owe very little in tax. Forcing the IRS to take equity is a self enforcing way to prevent the IRS from overtaxing people.
Basically you get stock from your options (which you exercise) and then you have to pay tax on the worth of that stock, which gets counted as a sudden income? I guess it makes sense you get taxed somewhat on this, as it is in a sense part of your income at the company, but I don't really understand how this works.
PREFACE Check with a CPA before acting on this advice! I'm not a CPA.
* If you sell in the same calendar year as you exercise, it's considered a "disqualifying disposition"
* The tax is actually Max(regular income tax, AMT). Normally your AMT (on your regular income) is lower. So you can exercise and hold just enough shares to "bridge you" to the point where the AMT is equal to the regular income tax. This way you will still be eligible for long term capital gains tax.
REMINDER Check with a CPA before acting on this advice!