The Taxation of Stock Awards: The Law Needs a Fix

If you are a worker rights advocate, I have an issue for you: the taxation of employee stock awards.

I know, this doesn't sound like your typical worker rights issue. This isn't the minimum wage. Or workplace conditions. 

But workers suffer because of how stock compensation is taxed. They suffer a loss of wealth because of the current tax rules. 

Let me explain. Suppose you work for a private company that wants to give you an equity award. The company wants to give you 100,000 shares of stock, which represents less than 1% of the issued and outstanding shares of the company. The company recently had a 409A valuation done and the company's common was valued at $1 a share. 

You can't accept the stock, because you can't afford it. What do I mean? If the company issues you 100,000 shares at $1 a share, you will have $100,000 of taxable income. And because you are an employee of the company, you will have to write a check to the company so the company can do what the law requires--withhold your share of income and employment taxes. 

Most private companies do not have the cash to pay your taxes for you. And if they did, that would also be taxable income to you, compounding your tax problem.

The tax withholding on $100,000 of income is significant. You will have to write a check to the company in the amount of about $30,000 (and maybe more). Most workers don't have this kind of money laying around. So, the worker can't take the stock. The worker misses out. This is bad public policy. 

But wait, you say, can't the worker get a stock option? Sure, but an option is not as good as a fully vested stock award. Why? Because options expire, typically 90 days after a worker quits providing services to a company. And if the worker doesn't have the cash to pay the exercise price and taxes by then, the option expires and the worker misses out.

I think the startup and early stage company ecosystem would be improved if Congress quit taxing transfers of illiquid stock to workers. Workers would benefit. These transaction are illiquid--meaning Congress is not missing out on taxing any cash transfers. The worker could take a basis in the stock equal to what the worker paid for the stock--zero--so that Congress could tax the entire gain later.

What would the benefits of such a fix be?

  • Companies could more readily share actual stock ownership with workers
  • Workers would be more likely to share in liquidity transactions in a more significant manner
  • Worker welfare would be increased.

Congress, could you get on this?