On July 12, 2016, The Empowering Employees through Stock Ownership Act (available here), was introduced in the U.S. Senate by Sens. Mark R. Warner (D-VA) and Dean Heller (R-NV), and identical legislation was introduced in the U.S. House of Representatives by Reps. Erik Paulsen (R-MN) and Joseph Crowley (D-NY). This important legislation gives private company employees the ability to choose to defer the tax obligations applicable when exercising their non-qualified stock options for up to seven years. Speaking in support of the bill, Sen. Warner said, “Extending employee stock programs to a broader universe of workers will strengthen business growth and create new economic opportunities, especially for rank-and-file workers.”
Most start-ups grant stock options and/or restricted stock units (RSUs) to employees as a significant part of their compensation. In the case of stock options, once vested, employees have a set period of time to exercise before the options expire. However, once the employee exercises their stock option, they are immediately required to pay income taxes (and social security taxes) on the difference between the amount paid and the fair market value. The same situation occurs when an employee’s RSUs vest.
The main challenge is that unlike employees in publicly traded companies who can sell all or a portion of their shares on the public market to pay for the taxes, private company employees generally do not have the ability to liquidate shares to cover their tax liability. As a result, the practical reality is that most rank and file private company employees will not have the cash to pay both exercise costs and the resulting taxes, so the stock option expires and the employee misses out on a significant financial opportunity.
Among other things, The Empowering Employees through Stock Ownership Act extends the time period in which employees are required to pay tax upon exercise of stock options or RSUs up to seven years (unless the company goes public). To qualify for the deferral of income tax, the company is required to grant options to 80 percent or more of its employees on an annual basis; must offer employees stock options on similar terms; and cannot be traded on an established market. The legislation is not intended to benefit the most compensated employees or the largest owners of a company. Individuals who own one percent or more of the company and those who control the company, such as the Chief Operating Officer, the Chief Financial Officer, and the four most highly compensated officers, are not eligible.
Government regulations, including the federal tax code, frequently ignore or forget employees working for private companies. This amendment to Section 83 of the Internal Revenue Code will greatly assist many employees who had found the only choice they had was to walk away from the equity they had worked so hard to earn. NASDAQ Private Market applauds and supports this legislation as another important Congressional development for private companies and their employees, a market that we are proud to serve and represent.