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Comment by adam-a | Hacker News Reader

I've not been in the position of buying options before, but is that really how the tax system works? I understand you have to pay tax on income from shares, but if you're buying shares you haven't had any income from them at that point right? I would have thought you'd just pay tax on any money you received when you sold the shares. Curious to know if that's how it works in the UK as well as the US, anyone have any pointers?

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Yes. It's a huge problem - the IRS demands liquid cash in order to pay tax on illiquid in-kind transfers.

The problem isn't just in startups with stock options; another big place it arises is closely held businesses. You receive the family business as an inheritance and suddenly you need to pay - in cash - 40% of the value of the business. Such a large cash hit can and does destroy many companies.

The solution is of course to require the IRS to allow payment in-kind (shares). Then you could exercise your options and hand over ~20% of your shares to the IRS. Or you could inherit the family business and give the IRS 40% of the the company (which suffers no cash flow hit and continues normal operations). This additionally would prevent the IRS from overvaluing in-kind earnings.

Why would the IRS want to own and manage family businesses?

I think the suggestion is that they'd merely own part it, but nonetheless it's not surprising the irs would prefer liquidity.

The IRS wouldn't want to own any part of a business. There is no reason for them to.

They wouldn't, and the original poster isn't implying that they would.

I believe the argument here is that if the government wants to claim that these shares have a certain monetary value for tax purposes, then the government should stand behind that value and allow you to pay taxes with those shares at their claimed monetary value.

The end goal would be to prevent small business (or people with stock options) from going under because the government claims a piece of paper is worth $1m, but in reality it can't be sold at all, or couldn't be sold for such a high value. If the government claims "oh but we would lose 20% of the value in selling these shares" then they are essentially admitting that they overvalued them when taxing you.

Further, I believe that is an option (requirement?) when paying your renunciation tax on abandoning US citizenship. You're required to pay taxes on all your assets as though they were liquidated that day, and to cover the case of illiquid assets such as employee stock options. [1] In this case they will take 30% of the value of the shares at time of disposition. This is something employees holding ISO and NSO could be allowed to opt into on exercise when there is a spread between FMV and strike.

[1] http://www.renunciationguide.com/expatriation-and-tax-detail... (Tax on deferred compensation and non-grantor trusts)

Or we could do away with the idea of giving people stock that they can't ever legally sell.

I wonder how much money the IRS looses due to this. So you can't pay the 40%, you end up closing shop. You both loose.

I'm surprised financial services have not popped up just to help people in such situations. The service could confirm the person has as much coming as they say, have him sign his life away to them, and then float him enough cash to buy the stock and pay the taxes on time. Then the employee pay some portion of his new wealth to the financial services company.

Does that really not exist?

They do exist but are very expensive. Basically by the time you go to them they know you are screwed and in desperate IRS-caused need of liquidity. So while the actual estate tax may be 40%, you wind up paying 50% or more. This is usually a debt deal, not an equity one - who wants shares in a closely held family corporation?

For developers at unicorns I think services are somewhat better (e.g. secondmarket, elite crowdfunder).

Often life insurance is purchased for this exact purpose.

Not true at all. For the last year for which data is available, 2013, only 20 inheritances of a small business were subject to the estate tax. [See http://www.cbpp.org/research/ten-facts-you-should-know-about...]

Additionally, estate taxes are paid by the deceased's estate. In the US, inheritors do not pay federal tax on their inheritance, and only 8 states tax inheritors.

Your citation gets that number solely by defining "small business" extremely narrowly and in such a way as to mostly exclude businesses affected by estate taxes.

Well, let's have fun with the words you chose. Hobby Lobby is famously a "closely-held family business"... and it has 23,000 employees and $3.3bn in annual revenue. I'm not going to lose sleep over that being subject to taxation, and though someone could spin it as "mom and pop's family crafts store", it would be disingenuous to do so.

It would be a pretty terrible thing for the world if this business died/were seriously hindered due to the need to come up with instant liquidity.

I have no idea why you and gamblor are obsessing over "mom and pop" or "small business" - that wasn't a claim I made at all.

The problem isn't with the tax system, but the corporate system.

Companies are giving out time-limited stock buying privilege to employees instead of direct ownership. Additionally, some companies can even revoke the privilege through termination of employment agreements.

If employees were treated as full owners, there wouldn't be a problem.

I don't disagree with you that the problem is with the corporate system, but it's also made significantly worse by the unfavorable tax treatment.

If the IRS didn't require you to realize gains on the spread when exercising, then a lot of these issues would dissolve. That's not to say folks wouldn't find other ways to restrict employee ownership.

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