Stan is right! If Sally is compensated in stock she will pay taxes on on it.
Luckily, I don't think my mistake on the hypothetical undermines my larger point.
Let's say that Sally's grandfather dies and leaves her $1000,000 which she uses on her first day on the job at Amazon to buy Amazon stock. In that case, she would not be taxed on the appreciation in the value of the stock until she sells it or dies. And if she dies, her heirs will be able to avoid taxes by means of the "stepped-up basis rule.
My point is that you don't get the tax advantages unless you have that $100,000 to get into the game. The little people are left out!
Stan F, a devoted reader, writes:
I agree with Prof. Denvir that there is a lot of inequality baked into the Internal Revenue Code.
However, his analysis of Sally’s tax consequences should she elect cash versus stock is wrong.
That mistake pollutes the rest of his discussion. We both agree that if Sally receives cash
compensation she pays tax on the earnings. Where we disagree is with the situation in which
Sally receives stock compensation with a fair market value (fmv) equal to the cash
compensation. Prof. Denvir states that in the stock case, Sally would defer her tax until the stock
is sold. That is incorrect. If Sally receives stock compensation with a fmv equal to the cash,
then she pays tax on the earnings. She does not defer anything. If she gets a Picasso in lieu of
cash compensation, she pays tax on the fmv of the Picasso. If she later sells the stock or the
Picasso, she may have either a capital gain or a capital loss, depending on her basis in the asset.
Whether that gain or loss is long- or short-term will depend on the holding period.
Here is my somewhat simplified understanding of the tax laws as they relate to earnings by
individuals who receive stock. Receiving full rights and title to stock with a readily ascertainable
fmv as compensation is fully taxable when received and at ordinary tax rates. Section 83
provides an exception if the right to the stock is restricted or if the fmv is not readily
ascertainable. I have not reviewed this section in some time but I believe that if a section 83
election is made by the issuer of the security, then the recipient realizes ordinary income initially
and capital gain or loss, if any, is realized later on disposition. I am aware of complicated
nonqualified stock compensation plans which hold the legal and equitable ownership rights to
stock until some earn out time period expires. Whether ordinary income or capital gain rates
apply at that time is an issue. Obviously the goal of such plan is to delay tax payment and
convert ordinary (salary) income to capital gain.
There are, indeed, features of the tax laws that favor those who can take advantage of them. The
one feature that materially helps the “little people” is the earned income tax credit. Most of the
features cut the other way. It would be better to focus on those features rather than to introduce
an incorrect and misleading example
Stan is right! If Sally is compensated in stock she will pay taxes on on it.
Luckily, I don't think my mistake on the hypothetical undermines my larger point.
Let's say that Sally's grandfather dies and leaves her $1000,000 which she uses on her first day on the job at Amazon to buy Amazon stock. In that case, she would not be taxed on the appreciation in the value of the stock until she sells it or dies. And if she dies, her heirs will be able to avoid taxes by means of the "stepped-up basis rule.
My point is that you don't get the tax advantages unless you have that $100,000 to get into the game. The little people are left out!