Disastrous Vesting Tax May Annihilate Stock Compensation

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The tax reform bill proposed by the United States Senate during the first week of November, if comes into effect, will charge eligible individuals on the basis of startup equity vests in-lieu of cash-out time; it may very well destroy how technology companies recruit talent. The bill was part of the larger “Tax Cuts and Jobs Act”.

Death taxes

The proposed tax will be levied on Restricted Stock Units and stock options. The proposed law will be applied when they get vested. The existing scheme comes into effect only when the stock options are exercised. Taxes are imposed only when the latter is done. The tax also gets imposed on when underlying shares get released for the Retired Stock Units (RSUs).

The sad part of this whole affair is that the industry does not have much time to get this document changed. The dilemma was explained wonderfully by the Vice President of Union Square Ventures, Fred Wilson. He said that the proposed tax implies that every month, when the equity compensation vests, taxes are imposed on it. He pointed out that the person on whom this tax is imposed cannot spend it or save it. This money cannot be imposed as well. This happens as the person does not have the money.

Problems with no end

This condition gives rise to a big problem. Only the wealthy could afford to pay such taxes. Others can only pay taxes after they liquidate their equity. This proposed tax will prevent a significant number of employees working in technology companies from accepting RSUs and stock options. The total incentive structure for premium talent does get broken. They will be afraid to take highly competitive jobs at companies. The tax scheme will punish performance failure with zero upsides. It follows that there will be hardly any takers for such jobs.

Companies will be compelled to give its employees much higher salaries. Big bonuses will be the order of the day. This tax will hurt startups the most as they lack sufficient capital to do these. Talented people will push top product, sales, design, and engineering people to take employment in larger and established companies which can afford better salaries and lump sum bonuses. Fewer people will invest in startups, thus resulting in reduced innovation. The cascading effect will be that American companies will lose their sector competitiveness on the global stage.

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