Illustration: Sarah Grillo/Axios

Sens. Bernie Sanders (D-VT) and Chris Van Hollen (D-MD) introduced legislation that would tax nonqualified stock options at vesting, rather than at exercise, for employees making at least $130,000 per year.

The big picture: Select employees at private companies would be taxed on monies that they hadn't yet banked.

The legislation is officially designed to "end tax advantages that allow CEOs to contribute unlimited amounts to special executive retirement plans," with proceeds going to "shore up multiemployer pension plans for 1.7 million workers." Startup employees are collateral damage, much like they would have been had similar language not been stripped from the 2017 tax bill.

What to know:

  • This only applies to employees making more than $130,000 per year and vesting more than $100,000 worth of stock per year.
  • That means it would be most likely affect employees at later-stage startups, where the strike prices are higher.
  • The proposal doesn't have a grandfather clause, but does include a nine-year transition period (i.e., this wouldn't apply until paying 2029 taxes).

Why it matters: Many of the affected employees, even though well-compensated, may be unable to afford the taxes.

  • Imagine you make $130,000 per year at a privately held company and have $200,000 worth of annual options vesting.
  • You obviously are required to pay regular taxes on your $130,000 income, but now also must pay taxes on $100,000 worth of stock options (again, the first $100k is excluded).
  • Or, put another way, you make $130,000 but are paying taxes on $230,000.
    • Not only might you not have the cash, but there's also the possibility that the stock will later go to zero or liquidate lower than your strike price — but the bill includes no claw-back mechanism. So you've now paid taxes on money you never saw.

Tax attorneys tell me that this legislation would likely result in companies shifting more from stock options to restricted stock units (RSUs), and also changing vesting periods to quarterly or yearly (because paying taxes monthly would be an administrative nightmare for both companies and employees).

  • But there are negative consequences to both: Companies typically provide fewer RSUs than options, because there's no strike price, and longer vesting periods could result in unhappy employees feeling compelled to stick around longer than they otherwise would.

Sources familiar with the legislation tell me that there could still be tweaks to the language, so don't be surprised if all of this gets addressed. Particularly given that a top Sanders campaign advisor is Rep. Ro Khanna (D-CA), whose district includes such Silicon Valley burgs as Cupertino and Sunnyvale.

The bottom line: This isn't about how much people pay in taxes. It's about when they pay it. It would make more sense for the timing to match the receipt.

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