Taxation of Stock Awards & Stock Bonuses

Stock Awards & Stock Bonuses

I am frequently asked how stock awards are taxed in the context of a private company issuing stock to employees or contractors as a work incentive.

The Taxation of Stock Awards and Stock Bonuses

Here is a short summary:

1) If the stock award is an award of fully vested shares, then the recipient of the award is taxed when he or she receives the shares, based on the value of the shares at that time.

2) If the shares are not vested, the recipient of the award is either:

–taxed on the receipt of the shares based on the value of the shares at the time of receipt, if the recipient makes an 83(b) election; or

–the recipient is taxed when the shares vest, based on the value of the shares when they vest. The trouble with not making the 83(b) election and waiting to be taxed is that when the shares vest they may be worth a lot more than when they were awarded. This can result in the recipient owing more in tax than the recipient can pay.

Here is how Fred Wilson described it:

The one downside to restricted stock is you have to pay income taxes on the stock grant. The stock grant will be valued at fair market value (which is likely to be the 409a valuation we discussed last week) and you will be taxed on it. Most commonly you will be taxed upon vesting at the fair market value of the stock at that time. You can make an 83b election which will accelerate the tax to the time of grant and thus lock in a possibly lower valuation and lower taxes.

This taxation issue is the reason most companies issue options instead of restricted stock. It is not attractive to most employees to get a big tax bill along with some illiquid stock they cannot sell. The two times restricted stock make sense are at formation (or shortly thereafter) when the value of the granted stock is nominal and when the recipient has sufficient means to pay the taxes and is willing to accept the tradeoff of paying taxes right up front in return for capital gains treatment upon sale.

Employee Withholding

If the recipient is an employee, then the employer has to withhold income and employment taxes from the employee. This means the employee will have to write a check to the employer upon the taxing of the award.

The taxing of the award can happen either at the time of grant or upon vesting. Therefore, an employer has to have a system in place to enforce the withholding obligation. The employer also has to monitor 83(b) elections.

What If Employee Pays FMV for the Shares?

Sometimes people think that if an employee or service provider has paid fair market value for the shares that somehow the tax problems go away. This is the case if the shares are fully vested upon purchase, and the employee paid fair market value for the shares.

But if the shares are subject to vesting the tax problems are not over. If the employee does not make an 83(b) election within 30 days of receiving the shares, then the employer will have a tax withholding obligation on vesting.

What Should You Do?

Just like Fred said, taxes are the reason most employees wind up with options. Congress could fix this problem. It seems to me that it would be very pro-worker legislation to provide that gross income does not include the receipt of shares in a private company.

General Disclaimer/Warning

Please be aware that this article is a general summary. If you are considering your personal situation, know that your documents may not be standard documents, and the summary above may not accurately apply to your personal situation.

Crowdlending: Peer-to-Business Lending

We are lucky today to have a great guest post by Tabitha Creighton, the CEO and Co-founder of InvestNextDoor. Thank you Tabitha!

Show me the money! (please)

Until recently investing in a small business has been inaccessible for the average investor.  Generally the only exposure a retail investor had to small business lending was when you were asked to loan money to your friend, neighbor or relative for their business.

graphic 2

So where have small businesses been getting money all these years?  Surprisingly, only 20% of the time they get their money from banks.  The remainder of the time they use their own personal credit sources, high interest alternative lenders, or just do without. [1]

Even private equity firms and hedge funds have had limited exposure to small business credit markets except through secondary markets buying wholesale portfolios of loans or securitized lending products.[2]

But why?  That’s simple. To lend to a business “officially”, you either had to be a bank or a commercial lender.  So if you weren’t either of those you could only lend to a business by buying the loans from the primary lenders.

Enter peer-to-business lending (or Crowdlending).

Peer-to-business (or Crowdlending) describes the function of retail investors being able to function as the primary lender to small businesses directly (typically through a “portal intermediary”).  For clarity, a “retail investor” is any person making an investment, rather than an institution or commercial lender.

This is different than the intermediated peer lending like Prosper or Lending Club, where borrowers are actually getting a loan from a bank, who then sells the loan to Prosper or Lending Club; and then they in turn, sell the retail investor an unsecured note to pay a return, based on the payments they receive from the borrower.  The visual below describes the difference:

graphics

Both forms of lending allow retail investors to participate.  The advantage of direct peer-to-business lending is that the retail investor gets all of the structural advantages of being a direct creditor (can hold a UCC filing, is a creditor in case of bankruptcy, collateral is possible), and all of the service benefits of intermediated peer lending (full servicing, dashboards, portfolios).

How risky is it?

Like with any investment there are substantial risks.  Default rates are typically in the neighborhood of 2% with a well-diversified portfolio (making many small investments, instead of one large one).  Most platforms use proprietary underwriting criteria similar to what the banks use to rate the risk and provide interest rates.

What does the retail investment opportunity look like?

Retail investors have the opportunity to participate in peer-to-business lending which has average returns of 5-12%, typically with monthly repayment over 1 to 3 years.  So, as Ron Suber, CEO of Prosper recently said at the 2014 Crowdfunding Symposium at UC Berkeley, retail investors will be given as much access to peer-lending markets as they want – but institutions will pick up any slack in retail demand.  And they are, and they’re making a tidy profit with returns in the low double digits – net of defaults and delinquencies.  Which is an impressive return for any fixed income investment – any investment, really.  In fact, for those who have fixed income investments earning double digit returns out of the peer-to-peer space, I’d love to hear where they’re coming from so we can all get in on the action.

Along with solid returns, you make a larger impact

So here is the most interesting thing, the social impact of investing in small businesses.  Small businesses are the engine of the economy.  They provide more than 50% of jobs and GDP.[3]  Providing them with capital to expand leads to more jobs, and the returns they give to their investors create more disposable income for consumers.  With a single investment we’ve increased Consumer Spending, reduced Unemployment and increased GDP.  All while making double digit returns for ourselves.

What are you waiting for?  Oh right where can you find these handy-dandy investments?

If you were in the UK or Europe, or even China, you could find them on any number of marketplace lending sites.  In the U.S., peer-to-peer investing is much more dominant, having grown to be more than $1B per quarter now.  Peer-to-business lending is only available on a select few sites right now, and institutions are buying more right now than retail investors.  Places to look for investments include InvestNextDoor, DealRaise, Raiseworks and P2B Investor.  Currently, Lending Club does not offer peer-to-business investments in its marketplace, and neither does Prosper.

So what’s the bottom line?

  • Peer-to-Business Lending is now accessible to retail investors
  • Banks and institutions are capitalizing on these types of investments
  • There opportunity for 10+% returns and a regular monthly cash flow
  • You become a small business game changer AND help the local economy

Author: Tabitha Creighton is CEO and Co-founder of InvestNextDoor

 

[1] Biz2Credit and Kaufmann Foundation studies

[2] www.cdcloans.com

[3] http://usgovinfo.about.com/cs/businessfinance/a/sbatopten.htm

Angels, Pitches and Beers

Folks have been asking a bunch of questions about this event. Such as how the event is going to work, how to sign up, whether they will be able to pitch, how the pitches will work, etc.

Here are the answers to the questions I have received so far. Don’t hesitate to email me or comment below and I will add more detail. We hope you can come.

Gary Rubens and I have organized a great group of angels for this event. It will be a great evening.

Will My Pitch Be Public?

No. Your pitch will be in a conference room with just you and your team and the angels.

Where do I sign up?

Sign up here. If you don’t sign up, don’t worry. Just come.

Will I get to pitch?

When you arrive there will be a pitch sign up sheet available. We will try to get everyone who signs up the chance to pitch. We might work on a first come, first serve basis. We might decide on some other method we will announce at that time.

How long will pitches be?

10 minutes. Timed. That includes Q&A time. So plan for that

Will I need a power point?

There will be a power point machine available, connected to a PC–so that you can quickly load a presentation if that is what you want to do. But be prepared to pitch without a power point if we have technical difficulties.

What should I bring?

Bring an executive summary one pager and business cards to give to the angels

How many angels will be there?

We expect 6-10 active angels to attend each event

How often will this event be held

We will gauge demand but possibly monthly or bi-monthly

Does it cost anything to attend?

No, all costs are taken care of by the organizers

Can I bring a friend or attend as a business promoting my services?

Please come but please know that we are trying to have a fun night focused on connecting angels to companies.

Live Blogging: SEC Investor Advisory Committee Hearing

Live Blog SEC Investor Advisory Committee Hearing