Hacker News Reader

Comment by KptMarchewa | Hacker News Reader

I don't understand why there's tax on unrealized gains there.

The gains are realised, you just aren't getting cash but company stock. The 'gain' is the difference between option strike price and market value of the shares. Since stripe is privat the market value is a bit murky but that doesn't deter the IRS.

EDIT: spelling

No, this is completely incorrect. The issue in question is about stock options, not stocks themselves. If you hold actual stocks, there is no tax bill until you sell these to realize the gains, and you can hold these forever. Instead, the issue at hand is about stock options. For those, the tax bill is due on exercise. For as long as you can hold the options without exercising, you don’t owe any tax, but the problem here is that you cannot have options that do not expire or have expiration date longer than 10 years. As this deadline is getting closer, option holders need to choose between exercising (and owing taxes on resulting difference between strike price and FMV), and forfeiting the options.

If they are ISOs, tax won't be due _upon_ exercise but will show up on that years tax return. Usually the AMT will hit you (if the exercise was worth it), and you'll owe the following year.

This is a slightly longer way of saying I'm not totally sure how what you're saying invalidates what valzam said: as far as the IRS is concerned, you did realize gains (you got something of value), just not on anything "liquid," hence AMT. Perhaps they (IRS) use different terms, but that's basically what's happening.

when the gain shows up is irrelevant - IRS requires taxes to be paid on income in the quarter it is realized. Everyone needs to pay the estimated tax and then file the return for the final adjustment.

I'm not super familiar with this aspect, so this could be totally off-base: because this is sort of "out-of-band" income, it might factor into what you should be paying, but you won't be penalized for it; you didn't know exactly what the estimated income was (i don't believe you have to get a 3921 immediately upon exercise) so you can't necessarily estimate the taxes owed. This could be totally wrong? Also, I think there's a lookback period of a year that you can base your estimated taxes on.

All of this to say, I think what you're saying is a much more precise way of saying what I was trying to get at. :)

If the stock is given to you as income, you owe tax on the $$ value as though it was income. Ask anyone who works at Google or any of the big corps who give RSUs. The number of them that hit your account is always about 2/3 of the number which actually vested. The rest are withheld as taxes.

Again, you are talking about stocks. Options work completely differently. Unlike with RSUs, you don’t owe any tax on options when they vest, only when you actually exercise. I know how RSUs works, I have actually worked at Google for a number of years. Instead, you should ask someone who works at an earlier stage company how options work.

Yes, I am talking about stock, in response to:

>> If you hold actual stocks, there is no tax bill until you sell these to realize the gains

There are taxes to be paid as soon as you get the stock. If you are at google - have you noticed the number of RSUs which hit your schwab account are less than those which vested according to that chart in your schedule? That's taxes being withheld. The stock vesting is considered income at that moment and taxed as such.

I may be woefully misunderstanding here but say you exercise your options, sell them then get real cash for the sale all in the same day. Can you use that cash to pay your taxes when tax season comes around?

You can use whatever cash you have to pay your taxes.

Yes. The problem is there are various reasons why you can’t just sell stock or an early stage company the same day.

Note that the 3.5bn (withholding) tax under discussion is not about options. It's about RSUs.

(There is also a less important amount of tax due - by more ancient employees - which is about options.)

It's about double-trigger RSUs with a 7 year limit. Stripe is now in year six. If they wait any longer, the RSUs become worthless (and the employees riot).

What's realized about these gains if the company is blocking the sale of the stock on the secondary market? This is toilet paper these people were duped into thinking was worth something. Sounds more like a lawsuit.

Yes for sure it's a raw deal for the employees, but I think Stripe is planning to enable a secondary market? In any case, we are all adults, they accepted stock options as part of your renumeration. If they don't know the risks then don't work at a private company that offers stock options.

EDIT: That being said, I think it would be reasonable to contemplate regulations that prevent private companies from blocking secondary market sales if they offer stock options/RSUs to employees.

To be fair, a venture-backed company remaining private for 10 years wasn't terribly common and probably wouldn't factor highly in anyone's risk assessment. If someone asked "what happens to these options in 10 years if you don't go public or get acquired?" they'd likely be ridiculed for being difficult. And I don't think start-ups want that to become the new mentality or they'll get more push-back on comp structure.

> If someone asked "what happens to these options in 10 years if you don't go public or get acquired?" they'd likely be ridiculed for being difficult.

Let's hit the presses: tech startups hate engineers that think of edge cases

> That being said, I think it would be reasonable to contemplate regulations that prevent private companies from blocking secondary market sales if they offer stock options/RSUs to employees.

Either that, or IRS not consider the exercise as taxable until those conditions imposed by the company preventing secondary sale are lifted.

How are they, if you're literally prevented from exchanging them to legal tender?

It's like taxing lottery tickets on potential win prize.

Actually that's not a bad analogy but against your point: options are winning lottery tickets. As long as you don't exchange them for the prize (the actual stock) you are not taxed. When you do, you have to pay tax on the difference between how much the options cost and the value you get back.

>Actually that's not a bad analogy but against your point: options are winning lottery tickets.

They are not unless you exchange them for legal _money_. Not stock.

>As long as you don't exchange them for the prize (the actual stock) you are not taxed.

Stock is not the prize - it's worth nothing alone, especially if you can't exchange it for mone. For some reason you don't tax unrealized gains on a stock you already owned, yet do the same for illiquid ones.

>When you do, you have to pay tax on the difference between how much the options cost and the value you get back.

And if you just taxed "at the end" when someone sells the stocks, you'd gain the same amount of money - difference between stock value and 0 - just in a different moment of time.

What I propose is logical and it's how it works in Poland.

What does the IRS use as market value?

Because the system is crazy, but it only affects early employees of successful startups so there's no political will to fix it.

Crazy isn't an explanation.

The problem is that "unicorns" in general or companies exploding in market cap are a relatively recent (i.e. dotcom era and afterwards) phenomenon, and the rules of the finance world didn't keep up with developments. At the same time, it affects only relatively few people, so the political incentive for fixing the situation in an increasingly grid-locked Congress is not very high.

Joys of the Alternative Minimum Tax. The difference between the exercise and the FMV counts towards your AMT income.

(Disclaimer: not advice of any kind)

the biggest joy is that you get it back in the form of a credit over several years, all the while paying interest and fees on the tax bill you cant initially pay because your "gains" are in a private company's stock that you cant sell! I've yet to get a rational explanation of why the current AMT law is fair. sure for some people it makes sense, but for the exercise of ISOs in a private company, it's basically robbery where they give you a chunk of what they stole back every year, and hopefully a liquidity event comes along sooner rather than later

It’s fair because otherwise you could compensate people for zero tax. For example, you have a CEO that can either be paid:

1) $1m in cash

2) $1m in stock

3) an option grant to buy 1m shares at $0.000001. Each share has a FMV of $1.

Without AMT, you could always take (3) and they would get $1m of stock for $1. Tax free.

So what? $1M in stock doesn't pay the rent. They'd still get taxed when they sell the shares.

Per Buy, Borrow, Die, they could take a margin loan using that $1M and use borrowed money (say $100K) to pay the rent. With enough accumulated shares, they wouldn't need to sell the shares in their lifetime. After they've passed away, they would pay off the loan and the stock gets a free step up to the appreciated cost basis.

that's assuming the stock is actually transferable though. that day could never come

How would you pay off the loan without selling at least the interest?

With (3), they'd be taxed on the gains when they sell. Not "tax free" at all.

The difference is that they wouldn't be taxed until the gains were realized not when they were imagined on paper.

The reason we have capital gains is to encourage investment. They're not investing $1 for 1m shares to build something better. They're getting $1m worth of something for $1, risk-free.

That gap between strike price and FMV is much more like compensation than it is an investment.

you can borrow against this asset and get basically a tax-free loan

Can you _actually_ borrow against completely illiquid, pre-IPO asset?

exactly this. tax time will come, hopefully. until then it's a tax on monopoly money.

Doesn't the option have to match the FMV at the time of issuance? E.g. Option 3 would be Option Grant at FMV of $1 with that constraint

But you can't sell those stocks/options/whatever until IPO. If you could I'd not mind.

Because receiving any kind of asset is a gain. For tax purposes an asset is valued at market or assessed rates depending on the type of asset (real estate, cars, stocks, etc.)

It’s tempting to think that we should just tax cash income, but that introduces tax avoidance incentives like being paid in assets instead of cash, unless it’s paired with a corporate income tax.

>For tax purposes an asset is valued at market or assessed rates depending on the type of asset (real estate, cars, stocks, etc.)

If you can't sell them on a market (as the stocks are before IPO) they should not be taxed. At the very least, it's like that in Poland. Not that a lot of companies offer stock compensation here.

While I personally think there ARE gains, even if you insist on there being no gains then there is simple tax adjustment.

An employee is compensated with *contracts* to buy stock. Those contracts *themselves* are valued at the strike price, i.e. an employee is accounted to gain ${strike-price} worth of value.

At some point said employee decides to exercise said option contracts, i.e. convert contracts to stock. At the moment of conversion stocks are worth x and ${strike-price} previously paid to employee magically turns into x.

You can either think that employee gained `x - ${strike-price}`, or that employee was previously taxed on ${strike-price} and tax base was adjusted to x. In any case there is income equal to `x - ${strike-price}`.

> While I personally think there ARE gains, even if you insist on there being no gains then there is simple tax adjustment.

How are those gains if you're explicitely forbidden to turn those gains into legal tender?

You'd get same tax when IPO hits - just without that earlier step.

Executing the option realizes the gain!

It's just the it realizes it into an illiquid asset whos price is imaginary nonsense. The problem of imaginary prices is one of the reasons that we don't tax unrealized gains, but it can still arise when the gain is realized if its realized into something illiquid.

Reply on news.ycombinator.com