On any given day in our nation’s capital, you’ll find many lawmakers touting the benefits of entrepreneurship. Unfortunately, this enthusiasm is all too often forgotten when it comes to our nation’s tax policy, which often either ignores or is outright hostile towards startups.
That is why when legislation does gain traction to massage the tax code to the benefit of startups and their employees, it’s worth cheering from the hilltops. As I write, there is legislation quietly making its way through Congress that could take a very productive step towards creating a tax code that supports entrepreneurship.
The House of Representatives recently passed a bill, the Empowering Employees through Stock Ownership Act, to allow startup employees to defer their tax liabilities on exercised stock options for up to seven years. This change is welcome news for the entrepreneurial ecosystem and startup employees across the country who are forced to pay taxes immediately on phantom income they haven’t received.
Here’s the issue.
As the U.S. capital markets have become more hostile to small capitalization companies, most startups are opting to stay private longer rather than pursue an initial public offering (IPO). In fact, the U.S. is averaging less than half the number of IPOs per year since 2000, which is costing the U.S. economy at least two million new jobs and, by some estimates, upwards of over twenty million jobs.
In fact, the U.S. is averaging less than half the number of IPOs per year since 2000, which is costing the U.S. economy at least two million new jobs and, by some estimates, upwards of over twenty million jobs.
Aside from the drag this places on the U.S. economy, it creates a growing challenge for employees at these startups who must exercise their stock options without a liquid market in which to sell their shares. If left unchecked, we run the risk of reducing the value of stock options as an effective incentive to attract and retain talent at America’s startups.
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Most cash-strapped startups dedicate their financial capital to developing and building new products and services, making stock options a critical tool for building strong teams. Talented startup recruits are used to accepting less in salary in exchange for stock options because they know that if the startup succeeds, everyone shares in the gains.
This is the secret sauce that underpins the innovation economy, aligning the interests of the startup founders, their investors, and team members to drive value creation for the country.
This value creation derived from startup activity is realized through the creation of 3 million American jobs annually and virtually all net new job creation in the U.S. since the 1970s.
Given their importance to our economy, U.S. policy should encourage talented individuals to help build startups into successful American companies. However, when a startup employee is served with a tax bill on income they have not yet received, our as tax policy is instead discouraging participation in the entrepreneurial ecosystem.
All too often, our tax code takes for granted our nation’s startups, choosing instead to stack the deck in favor of incumbent corporations. Take for example the research and development tax credit that is largely worthless to startups. Or NOL limitation rules that have the unintended consequence of effectively punishing startups for investing too much in innovation. These are just two examples of a tax code that far too often gets in the way of entrepreneurship.
The Empowering Employees through Stock Ownership Act is a common sense solution to a challenge presented by a tax code that has never been updated to recognize the realities of the entrepreneurial ecosystem. It’s champions, Congressmen Erik Paulsen (R-MN) and Joe Crowley (D-NY) and Senators Mark Warner (D-VA) and Dean Heller (R-NV), should be commended for their efforts to make a tax code that recognizes the realities of the ecosystem. NVCA will push to make their colleagues take notice and offer additional solutions to actually support entrepreneurship in America rather than simply talk about entrepreneurship in America.
