U.S. Sens. Mark R. Warner (D-VA) and Dean Heller (R-NV), members of the Senate Finance Committee, along with Reps. Erik Paulsen (R-MN) and Joseph Crowley (D-NY), members of the House Ways and Means Committee, reintroduced bipartisan and bicameral legislation that would make it easier for startups and businesses to give employees an ownership stake in their company’s success by awarding stock options. Similar legislation was previously introduced in the 114th Congress.
Stock options, which are a right to purchase shares of a company at a future time at a fixed price, are an important tool for investing in and rewarding employees and increasing their compensation, but the tax implications often make this impractical for many employees of non-public firms. The Empowering Employees through Stock Ownership Act (EESO) promotes broad-based employee ownership by reducing this barrier to participation, giving employees new flexibility in handling their tax obligations for up to seven years after exercising their stock options. In order to be eligible, stock options must be extended to 80 percent of the workforce, and majority owners, corporate officers, and the highest-paid executives will not be eligible for the seven-year tax deferment.
“Giving more employees an opportunity to own a stake in their company can have a profoundly positive impact on workplace culture and productivity. Stock options can help rank-and-file workers share in their company’s success, and also offer cash-poor start-ups an important tool for recruiting and retaining top talent,” said Sen. Warner. “This bill encourages start-ups and businesses to expand employee stock programs beyond top management and across a broader universe of workers, which will help create new incentives and economic opportunities for businesses and their employees, too.”
“Employee ownership is a powerful tool that not only provides greater economic opportunity for employees, but increases employee engagement, motivation, and drives economic growth across Nevada and this country,” said Sen. Heller. “Our legislation makes it easier for startups and small businesses to award stock to their employees, which will ultimately help them retain and attract talent and fuel entrepreneurship.”
“American startup companies are the birthplaces of many breakthrough, forward-thinking ideas and technologies, and we need to ensure they are attractive places to work for top talent,” said. Rep. Paulsen. “This commonsense proposal empowers employees of these companies to have more ownership stake in their ventures, and further encourages innovation and entrepreneurship.”
“This commonsense bill gives American workers the opportunity to share in the success of companies they help build,” said Chairman of the Democratic Caucus Joe Crowley. “These are the types of workplace environments that should be fostered – ones where workers are engrained into the fabric of the company, have an economic stake in its success, and see their compensation increase as the company succeeds.”
Under current law, employees are required to pay taxes when they exercise their options or when their Restricted Stock Units (RSUs) vest. In other words, to access their employee ownership stake, employees are required to pay taxes on the excess of the fair market value of the stock – the difference between the amountpaid and the fair market value – and the employer receives a tax deduction on the date the employee exercises the option.
For companies that are publicly traded, employees can sell all or a portion of their shares on the public market to pay for their taxes, but in the case of privately held companies, there is generally not a market for employees to liquidate shares to cover their tax liability, and as a result, many employees are unable to exercise their stock options, missing out on the opportunity to gain wealth as their company succeeds.
“Stock options are a critical tool for startups to attract, retain, and incentivize top talent, but the existing tax regime around stock option compensation makes it unnecessarily difficult for employees to realize the value of their equity. The Empowering Employees through Stock Ownership Act will allow more employees to obtain a stake in the companies that they help to build and grow,” said Evan Engstrom, Executive Director at Engine. “This policy change is a no-brainer and a win-win for both startups and their employees.”
In addition, the legislation has the support of nearly 70 companies. A full list can be found here.
The Empowering Employees through Stock Ownership Act will:
- Reduce the barrier to exercise stock options: The legislation extends the time period in which employees are required to pay tax upon exercise of stock options or RSUs that are settled for stock up to seven years. The amount of tax the employee can elect to defer is calculated in the same manner as under current law: the excess of the fair market value of the stock, over the amount the employee pays for the stock.
- Promote broad-based employee ownership: To qualify for the deferral of income tax, the company: is required to grant options to 80 percent or more of its new employees on an annual basis, and 80 percent of employees need to hold options on an annual basis; must offer employees stock options on similar terms; cannot be traded on an established market. The legislation is not intended to benefit the most compensated employees or the largest owners of a company. Individuals who own one percent or more of the company and those who control the company, such as the Chief Operating Officer, the Chief Financial Officer, and the four most highly compensated officers, are not eligible.
- Require employees to be fully informed: There may be instances where the stock price of the company declines after the employee elects to defer income tax liability. It is critical that employers provide employees with information, through a written notice, on the tax consequences of this election, and failure of the company to provide a notice to an employee will result in a penalty.
- Use existing administrative tax rules and provide worker flexibility: Similar to other tax elections in the stock options space, the employer will be required to report the future tax liability on the employee’s Form W-2. Once the employee has the cash to pay the stock, a tax deferral is no longer permitted. In other words, if stock of the company becomes readily tradable on an established market, or the employee decides to sell or transfer part or all shares to another individual before the seven-year time period ends, the employee will have to pay tax. The employee can also decide to revoke the deferral and pay his or her income tax at any point.
For more information on this bill, click here. A copy of the bill text is available here.
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