Chaos Monkeys: Obscene Fortune and Random Failure in Silicon Valley talks about a tax situation that seems to apply to the typical employee of a California tech company:
[Reflecting on his startup co-founders’ profits from joining Twitter] We’re still on speaking terms, more or less; Argyris and I more than MRM, but that’s hardly surprising from what you’ve read. They’ve managed to forgive whatever slight they felt at the deal drama I created. After all, it worked out very well for them in the end. And my outcome? Practically nothing by comparison. Recall, the Facebook offer was in restricted stock, which is taxed as common income. Also recall, Facebook’s IPO, unlike Twitter’s, came out at a high price of $38, and then languished for a year around $30, occasionally going so low as $18. That IPO was great for employees and insiders worried about dilution, but not for people wanting to cash out (like me), and walk away from the Silicon Valley casino. With the lockout, insiders weren’t able to sell the stock until months after the IPO, when FB was at $20. Thus I owed taxes at the maximum marginal tax rate (plus whopping California state income tax) assuming a cost basis of $38, when I had really sold at lower, effectively paying taxes on money I hadn’t made. In a smaller way, mine was the plight of the first tech-boom bankruptcies, who paid taxes when prices were dear, but sold stock when prices were cheap.
How does this actually work in practice? Stock given by a Silicon Valley company to an employee is valued on a particular date? Which date? The date on which the employee is hired? The dates on which stock is actually vested and at the market price at the time? Via some other mechanism?
[Separately, Martinez shows the hazards of getting rich via aquihired… you can also become poor when you get acquifired before vesting the shares purported received a part of the deal. On the vesting process:
This is what it feels like to go from a startup to a big company. Even Facebook, whose ability to maintain a fast-moving, always-be-shipping culture well into corporate middle age was admirable and unique, was simply a German-style autobahn, not a racetrack. The days of a few engineers going rogue and launching Facebook Video despite Zuck’s wishes were long gone. Most vehicles moved at the speed limit, lots of trucks hogged the right lane, and a select few drivers traveled at full speed in the left lane (with no-speed-limit passes given out by Zuck alone, and anyone else who dared race ahead did so at peril to his or her career).
As early as a few months into Facebook, once the novelty had worn off, I could feel myself growing bored and frustrated with the speedometer stuck in the middle double digits. Product development in Ads was sluggish and curiously hesitant. The targeting team continued trying to squeeze juice out of the dry data lemon, and Gokul kept on riding the Ads team mercilessly, while offering nothing in the way of direction. The Facebook cast was unfailingly competent but not the race car drivers of my previous startup life, and it seemed I was waiting to get somewhere. Given the nature of technology compensation, I actually was.
I’d have to patiently wait out my vesting schedule; the joke term for doing so in less spirited companies than Facebook was being a “VIP”—that is, “vesting in peace.”
To measure progress, I put a countdown clock app on my MacBook’s dashboard, measuring the time until my first vesting, beyond which I already couldn’t imagine staying. The clock counted in minutes, hours, and days, and I referred to it often, especially after a particularly challenging meeting that reeked of corporate cant and catatonia
Here’s what it was like to be fired:
“You’re a very divisive figure, Antonio. I read the reviews of your team members, and then that of management. They’re completely opposed. One loves you, and the other hates you.” “That’s true, Boz. I’ve certainly made friends and enemies here. But my goal has always been to give Facebook the best ads system possible.” This was, in all seriousness, true. I could barely remember what my life was like before Facebook, and there was a trail of destruction I had caused by spending my entire life there: two children neglected, two different women whose worthy love I’d spurned, two boats rotting in neglect, and anything like an intellect or a life outside campus nonexistent due to indifference and my dedication to the Facebook cause.
There were few women one would call conventionally attractive at Facebook. The few there were rarely if ever dressed for work with their femininity on display in the form of dresses and heels. A fully turned out member of the deuxième sexe in a conference room was as clear an angel of death as a short-barreled .38 Special revolver. Gokul gave an awkward smile, and bolted out the door the moment I sat down. I looked across the table. If her look was supposed to disarm me, she needed either more cleavage or more charm. I glared at her as she read through her script. “We are offering a severance package . . .” Here she switched into the false sotto voce that professional manipulators, like salesmen or politicians, use to make a cheap bid for personal intimacy. “We offer this to very few employees . . .” She slipped a contractual-looking document across the table. Non Disparagement Clause. . . . $30,000 . . . . For one year from the date of this document you will not . . . Ha! I saw the game. This had a unique Gokul stench all over it, like that of roadkill skunk. Knowing my penchant for hyperbolic criticism, and my flair for garnering attention with a well-worded Facebook post, Gokul had decided to bribe me into silence. This additional shut-up clause would strengthen Facebook’s ability to sue me should it choose to.
We reached my desk, which was impeccable for once, positively shining from my weekend ministrations. There was nothing on it except my laptop. “Where’s your laptop?” “Right there,” I said, pointing. “Where’s your phone?” “I forgot it at home.” “Hm, where’s your badge?” “I also forgot it at home.” I, of course, hadn’t forgotten anything. The badge would get me discounts at the Apple store forever. And the phone I hadn’t wiped yet.
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More: read Chaos Monkeys: Obscene Fortune and Random Failure in Silicon Valley
The transaction was structured so that the payments in stock were deductible as ordinary wage compensation expenses by Facebook, so the IRS wants the employee to consider it as wages also – my deduction is = your income. The deduction/income = the difference between the fair market value of the stock granted (at the time of granting) vs. the “strike price” of the option (the amount the employee has to pay when he buys the stock). So if the FMV at the time was $38/share and he had an option to buy for $1/share, $37 would be ordinary income. Later when he sold the stock for $20, he would have a capital loss of $18/share so it’s not as bad as he made it sound. Although he might need other capital gains to wash against the losses in order to actually take the loss on his return (otherwise it carries forward).
There are other types of options where the tax treatment is more favorable to the employee but Facebook gave out the kind that favored them.
The stock options I had at Symantec were based on hire date. That was for a regular employee, though. Back when regular people could see reports of executive stock option exercises, around 15 years ago, the executives were giving themselves options with prices at most a third what we got.
That Non Disparagement Clause mentioned is a fairly standard thing in severance agreements. When I got laid off from Symantec they the severance agreement had one, with a $60,000 bribe attached. I passed on the bribe, though, because I found the non-disparagement clause offensive. Ironically, the only bad thing I had to say about Symantec after that was to criticize the non-disparagement clause. Symantec didn’t really need my help to look bad in general.
In the first dot-com crash, many paper fortunes were wiped out by the alternative minimum tax. Not sure if that still applies, many more established firms (already public) have switched to restricted stock grants.
They used to base the sale price of stock options on the highest price the stock reached, at some point in the past. That was the back dating scandal of 2001. The SEC put an end to that, but we had another game planned for 2008.
Re: taxation of stock options, probably more than you want to know…
There are really two sets of rules: one for Incentive Stock Options (ISOs) and one for “Non-Qualified” options.
I’m assuming that all the options are granted at “market price”, which is almost universal; if not the difference between the grant price and the market price is taxable income.
For ISOs, there are two taxable events. One is the gain when you exercise it. This counts towards Alternative Minimum Tax (AMT), but not the regular tax. The second time is when you sell the stock. If its been more than a year since option exercise then it counts as long term capital gains. Less than a year is ordinary income.
Non-qualified options are simpler. Any gains between the option price and the market price at exercise is regular income. Any gains from extercise to sale is a short or long term capital gain.
Theres one more complication that probably doesn’t apply to this case, but can effect early employees. You can exercise your options before they vest to avoid the AMT tax by filing an ’83(b)’ election, that basically says “ignore the vesting schedule for tax purposes; by basis is when I bought the stock”.
Another consideration is that if the options were granted pre-IPO, the strike price would be a figment of the collective imagination of CFO and investors. Many early employees will have a tough time coming up with the cash for an 83(b) election, so they’ll get hit hard on AMT, often forcing them to sell shares (if not in lockup) at an unfavorable time just to cover taxes on paper gains.
He specifically says “restricted stock” which I assume is short for restricted stock units or just straight up stock as opposed to options which all the other comments are talking about (which are very different between nqso’s and iso’s in their tax treatment). For restricted stock the full price of the FMV of the stock is taxed on the day at short term capital gains (income) that it is granted and withheld from the shares you receive (not sure what % they guess). You can then try to hold the shares for a year and pay long-term gains on the change (which would have worked out at Facebook given how much it shot up after a year). Or you can sell immediately. Which it sounds like he did. When it tripled over the next year I’m sure he felt screwed.
Note: I’m not a CPA or any sort of tax authority but do have rsus.
Day that it vests (for RSUs) I meant to write.