Examining the Tax Advantage of Founders\u27 Stock

Abstract

Recent commentary has described founders\u27 stock as tax-advantaged because it converts founders\u27 compensation income into capital gains. In this paper we describe various founders\u27 stock strategies that offer this character conversion and then analyze whether they are, on the whole, tax advantageous. While the founders\u27 stockstrategies favorably convert the character of the founders\u27 income, they simultaneously turn the company\u27s compensation deductions into non-deductions. Whetherfounders\u27 stock is tax-advantaged overall depends on whether the benefit of the founders\u27 character conversion outweighs the cost of the company\u27s lost deductions. We use various hypothetical to illustrate this tradeoff. We conclude that founders\u27 stock is likely to be significantly tax-advantaged only in those cases where the start up company shows great promise early on but ultimately never develops into a profitable enterprise.Even in that subset of cases where founders\u27 stock turns out to be tax-advantaged, the advantage exists only because of the tax law\u27s overly harsh treatment of net operating losses. Therefore, whatever tax advantage that exists for founders\u27 stock is best viewed as a partial move towards the optimal treatment of tax losses, not as a stand-alone tax benefit that needs to be eliminated