Reintroducing the Income Tax Deferral on Equity Compensation

Ideally, it would be fair for all employees whose sweat equity increases the value of a private company to share in the ownership of that company. But under current tax law, this type of employee compensation policy can be prohibitively expensive. Employees must generally include stock compensation in their taxable income at grant or when the shares become substantially vested. Likewise, stock options are generally included in income upon exercise, which allows for some timing of the income tax, but also subjects them to an expiration date. This means employees who wish to acquire stock in their company may be forced to pay a high amount of income tax in the absence of liquid assets. If an employee cannot afford to pay this tax, then the employee will be discouraged from sharing in the company’s wealth.

The Empowering Employees through Stock Ownership Act (H.R. 5719) was introduced in July 2016 by Rep. Erik Paulsen to help implement better employee compensation policy. The House passed the bill in September 2016, but it was not passed by the Senate before the end of the 114th Congress. If this bill is revived and enacted by the 115th Congress, it will permit growing companies to issue stock to their employees without triggering the immediate inclusion of taxable income. The goal of such legislation is to alleviate the hardships imposed by the tax treatment of stock compensation in small, startup businesses as well as larger, private companies.

To accomplish this goal, the bill allows an eligible employee to elect to defer taxation until an event triggers the cash or cash-equivalent that the employee needs to pay the income tax on the stock compensation, thereby empowering the employee to reap the benefits of increasing the company’s wealth. To help ensure this tax expenditure will be used to properly incentivize shared ownership, the company would be required to provide the stock compensation to at least 80 percent of its workforce. Further, the income deferral would not be available for top management and top paid employees. Thus, reintroducing this bill would provide adequate protection against potential managerial abuse in addition to improving the economic incentives available to hard-working employees.

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