Bills introduced in the House and Senate on July 12 would make it easier for startups and private businesses to give employees an equity stake in their company's success. These bills encourage awarding employees stock options or stock settled RSUs (Restricted Stock Units) due to increased flexibility for paying the taxes owed upon exercise (options) or vesting (RSUs). Employees generally pay taxes in the year they exercise options or when their RSUs vest, but this bill would allow them to defer those taxes for up to seven years as explained in a blog post from myStockOptions.com.
The sponsors of the Empowering Employees through Stock Ownership Act (EESO) in the Senate are Senators. Mark Warner (D-Va.) and Dean Heller (R-Nev.). An identical House bill is sponsored by Rep. Erik Paulsen (R-Minn.). In the Press Release Sen. Warner said, “When employee ownership is spread across a growing business, it has a huge impact on workplace culture, productivity, and wealth creation. It also is a key tool for startups, allowing cash-poor innovators to recruit top talent. 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.”
Under current law, to access their ownership stake, employees are required to pay taxes on the difference between the amount paid and the fair market value. For companies that are publicly traded, employees can sell all or a portion of their shares on the public market to pay for their taxes, but in the case of privately held companies, there is generally not a market for employees to liquidate shares to cover their tax liability. As a result, many employees are unable to exercise their stock options and sell company stock so they are missing out on the opportunity to gain wealth as their company succeeds.
To qualify for the income tax deferral, the company is required to grant options to 80 percent or more of its employees annually, agree to provide information about changes in stock price and report the future tax liability on each employee's Form W-2. Majority owners, corporate officers and the highest-paid executives will not be eligible for the seven-year tax deferment.
The deferral election for qualified equity grants would need to be made by employees within 30 days of either when the options are exercised or when the RSUs vest. If the company were to go public or the employee were to sell the shares for cash during the seven-year period, taxes would have to be paid at the time of the liquidity event. The deferral election could also be revoked by the employee at any time, triggering taxes at that point. Issues regarding grant structure, filing details, early-exercise option applicability and whether Social Security and Medicare taxes would also be deferrable still need to be clarified.
A copy of the bill text is available here