I can hear all the non-US persons reading this article and laughing about all the insane idiocy that we put up with from the US tax code and IRS.
All US persons have to put up with at least this amount of calculation every year (otherwise pay more than is strictly necessary, or possibly suffer penalties and fines later), and the details constantly change with the political tides.
This is why tax reform crops up as an issue every 4 years, though it somehow never manages to survive past primary season to the general election.
Tax reform never survives because there is no consensus on how it should be fixed. Some folks think we should "simplify" by eliminating deductions - things like home mortgage interest, child care expenses, medical expenses & health insurance premiums. Other folks think we should "simplify" by eliminating corporate tax breaks & subsidies, and change how we tax things like stock trades & financial instruments. Still others think we should scrap the whole system and just impose a flat tax. Everyone benefits a little under the current system, and no one wants to trade the devil in the details of a "reformed" system for the deal they've got now.
The ideas that are tenable can't be popular enough to succeed (since we're all just temporarily disenfranchised millionaires, and it could always be worse), and the ones that are simplest aren't palatable once all the details are worked out. So we do nothing, because that's easy.
The IRS sends you a summary from all your various W-2s and 1099s for the year. It has two numbers: what you earned as income, and how much you already paid for income tax this year.
And it sends you your tax form. If you earned less than the median annual income for this year, you owe zero. If you paid anything already, you get all of it back with the enclosed check.
If you earned more, you see the result of the automatic calculation, such as tax( income ) = max( income - median_income, 0 ) x tax_rate . That's an easily-calculated, slightly-progressive income tax, with only three computation steps. If you paid more than what you owe, you get a refund. Otherwise, you could, at that point, file the forms for additional politically-motivated deductions or credits, or just pay the difference and be done.
This has the notable advantage, thanks to using the single, easily-determined statistic of median income, of cutting the number of tax filers in half--specifically the half that would otherwise pay the least amount in tax. And that half can gleefully vote for the reform! Them along with the median-plus-one person constitute a simple majority in favor.
Anyone can sit down and come up with a better way to collect income tax from the perspective of the tax-payers. Anyone. Yes, even that guy. The problem is that the tax-payer perspective is not a factor when it comes to implementation. At that point, it is the perspective of the tax-collectors that matters. And from the perspective of the collectors, a system that offloads all the work onto the payers, and where any mistake at all could generate more tax revenue, is simply perfect. And the more confusing, the better, because unclaimed deductions increase revenue, and honest mistakes generate penalties.
That sounds great, except it has absolutely nothing to do with "half plus one" in the first place. It has to do with electable legislators plus their interest in pushing for this.
The pain with american stock options is you have to pay tax on exercise & liquidation with private non-liquid stock. When you exercise stock options in canada you only have to pay on actual liquidation, not on exercise.
So for example you have an option for 0.10, the FMV is 0.50 when you exercise and you eventually liquidate at 1.00.
In the USA you have to pay tax in the 0.40 'gain' right when you exercise. Then when you sell at 1.00, you pay another tax on the 0.50 gain that you had. The problem with paying tax on that 0.40 'gain' right away is you cannot sell the stock you receive easily to anyone like a public company.
Also capital losses can only tax deduct your real income a small amount in the USA. The rest stays around as a credit for your capital gains. So in the USA, there are large incentives to not exercise your startup stock options, and on top of it, they typically expire 90 days after quitting.
In Canada, when you exercise you pay no tax, but when you liquidate you pay tax on the 0.90 'gain'. I don't know how the long term / short term capital gains interact in this situation. Capital losses can also deduct fully from your income, so the pain of a startup that goes south is significantly less.
I don't know the details that well, so what is actual reality could be different. Go consult professionals.
It's worse. In some years, the gain when exercised was treated as ordinary income from your employer. So unless you filed a bunch of extra forms, the 0.40 per share might have been taxed as ordinary income on your W-2 from your employer, and also reported on a 1099 from your brokerage. Then it could have been reported again when you liquidated.
This is exactly what happened to me in 2002. The IRS wanted me to pay about 180% of what I actually earned from an options transaction in taxes. The employee stock purchase plan interaction only made it worse, thanks to the difference between long-term and short-term capital gains.
It was a complete CF, and made me ultra-paranoid about non-paycheck compensation forever after.
Don't just consult a professional. Form an angry mob and yell at some politicians. Try to get paid for your work with cash instead of options.
"All US persons have to put up with at least this amount of calculation every year "
This is most certainly not the case. My taxes aren't that complicated (despite having to file in two states each of the last few years, and three states this coming year), and I was doing the 1040-EZ up through about 2009-ish.
You can't know if your itemized deductions will exceed the standard deduction unless you itemize your deductions on a draft schedule A. There is a chance that you could have owed less tax if you used the regular 1040 form, rather than the 1040-EZ, if you had medical expenses, gave to charity, had a home mortgage, suffered a loss due to crime, paid tax in another jurisdiction, etc, etc, etc.
And if you use the 1040-EZ, there's also a good chance that you filled out some worksheet to see if you were eligible for the earned income credit, or some other speculative calculation that might reduce your tax, if and only if the number you get at the end of the calculation is nonzero. And in theory, everyone always has to check to see if the AMT is greater than their calculated 1040 tax.
One of the perennial excuses I hear for not replacing the bracketed tax tables and forms with a single polynomial function is that it would be too complicated. Clearly, that's a bullshit reason.
That required you to have prior knowledge of what you could have deducted. If you didn't have such knowledge, your ignorance might have caused you to pay a higher amount of tax than you otherwise needed to.
This is why automated tax software asks so many questions about potential deductions.
the point is that there is almost always a non-zero amount of work you have to do to file your taxes. Depending on your situation the amount of work can increase.
For a large chunk of people the IRS already knows what they're supposed to be paying. Those people are still put throughout the 'tax return' exercise.
I think the other commenters are right that for someone that's not familiar how taxes work in the US this seems overwhelming. I know I had a few people laugh/be amused when I was first attempting to figure out how it works and actually attempted going through the 1040 instructions. The reactions I got: blank stare + dude that's what turbotax is for...
And TurboTax spends a lot of money on lobbying [1] and advertising [2] to ensure that, first, it doesn't get any easier to file directly with the government, and second, that consumers think "TurboTax" when they think about tax software. The last sentence of your comment is exactly what Intuit wants to engineer.
[2] http://adage.com/article/special-report-super-bowl/turbotax-...
The ads themselves aren't important so much as the fact that they air during the Super Bowl, one of the most effective and expensive ways to make sure millions of people see your message.
How concerned should I be about my employer (sizable company, ~300 employees) being reticent to divulge our 409A valuation with me? I've had a hard time (read: never did get; only got my options' fractional ownership in percentage terms after long nagging email chains) in the past getting any information to this effect, and we just raised another round a few months back, so I would like to estimate my tax burden, but they don't seem keen on sharing.
If you're eligible to exercise any options, I would be concerned; you can't make an informed decision without knowing the tax consequences. You might want to phrase it as you'd like to exercise some options, but you need to know the 409a valuation so you know how much AMT you can afford.
If you're not yet vested and there's no early exercise provision, you don't need to be super concerned, since you can't take any action anyway; but I would be sure you're getting the compensation that you want in a form you can value (salary).
Would I be accurate in restating your last point as "if they won't tell you what the shares are valued at or how big the pool is, and they just give you a percentage, you have no clue how much the equity is actually worth?"
Very concerned. They have a legal obligation to tell you this number so that you can properly pay your taxes. Companies that aren't willing to share this data are reasonably likely to be screwing you.
If you have vested options, then you can exercise one of them to officially become a shareholder at which point you will have access to a lot of additional information. As only an options holder, there's no legal requirement for them to share that with you.
However, I would be concerned at a fundamental level because, good or bad, they're not being honest with you about the most basic state of the company. You have to ask yourself if that's even the kind of place where you want to be working.
For the sake of planning: The difference between what you paid (you have to exercise options for this to matter) for your shares and what the are worth (see the company's most recent valuation) is counted as income for the current tax year.
If you hold the shares for more than a year, the money you make on a sale is subject to capital gains tax. This is indeed affected by WHEN you buy shares, so make sure to take monthly purchases (if you vest monthly) into account.
When you file your taxes: Hire someone; don't try to do this yourself.
I hired a certified tax professional; he had never handled ISOs before and got it wrong. I did it myself, and it wasn't really that bad. Hired a different CPA to double check it, and he said it looked fine.
That being said I still suggest to everyone who has never been through it before to get a professional involved.
Ha, yeah, now I know not all tax professionals are created equal. He of course acted like he knew how to handle it right up until the end and only let it slip once that this was the first time he'd actually handled them. His advice ended up being "they're not taxed, just ignore them until you sell the actual shares" which I knew was wrong.
> When you file your taxes: Hire someone; don't try to do this yourself.
I don't necessarily agree with this. The median person intelligent enough to work for a successful startup is competent enough to handle the tax implications of stock option exercise. True, it's time consuming to read enough to know what you're doing (e.g. what forms need to be filed), but the actual paperwork and calculations are not complex.
Ok. I'm a tax professional so I may have a vested interest. But the problem is there are a lot of questions you may not know to ask. Sure, filling out the forms is the easy part. Knowing what goes where, why & what carryover provisions apply is the hard part.
For example the OP just said options. He didn't say if these were ISOs (although my response assumed they were). Even if they were ISOs, were the options for restricted shares? Did he make an 83(b) election at grant? What if he thought they were ISOs but they were really non-qualified options or restricted stock units. (I've seen that happen but by the time I got the info as a preparer, it was too late to do anything except pay the tax.) These all are taxed and reported differently.
If you're talking a lot of money, I would find a qualified tax professional. Make sure the person you hire has experience with stock compensation.
You should find this someone now, before you exercise, to make sure you're planning for the tax implications. On the OP's exercise, there will be no tax withheld on the transaction, but the US has a pay-as-you go tax payment requirement, so the AMT tax on the exercise could be due now, rather than April 15...but there are safe-harbor rules that could mitigate this requirement....see what I mean... there's an awful lot to know which is why we're required to have so much annual CPE.
CPAs are not the only option and not all CPAs specialize in taxation. Enrolled Agents are licensed by the IRS, rather than the states like CPAs & attorneys. Whoever you hire, make sure they have experience in this area.
It completely depends what type of options you have.
If they are incentive stock options then you will need to report the value of the bargain element (fair market value of the options less the amount you actually paid) as AMT (alternative minimum tax) income. The AMT tax rate is ~27%.
Say your stock is worth $110 and you pay $10. Your bargain element is $100 and your AMT is ~$27, federal. Your state could also have tax reporting requirements on the exercise of your options.
This assumes you exercise and hold. If you sell the shares after exercise a whole host of other issues come into play.
Would it be fair to say that, if one was set on exercising, that they do so for whatever amount has vested after their one year cliff, and then exercise the remainder (13/48-48/48) each month over their 4 year earn out in order to have as much of the stock covered under long term capital gains tax when it comes time to sell?
This assumes your shares are worth more than your exercise price. :)
In order to get long-term capital gain treatment you will need to hold the shares for 1 year + 1 day. And more than 2 years from the grant date (this part usually isn't an issue).
By exercising every month after the 1 year cliff you essentially dollar-cost averaging your purchases. You might also want to use a similar strategy when it comes time to sell.
Also keep in mind that the long term capital gain rate is currently 20% plus 3.8% net investment income tax. (Again this if federal only).
All US persons have to put up with at least this amount of calculation every year (otherwise pay more than is strictly necessary, or possibly suffer penalties and fines later), and the details constantly change with the political tides.
This is why tax reform crops up as an issue every 4 years, though it somehow never manages to survive past primary season to the general election.