Equity Compensation Archives

How Sam Walton Taught Zuckerberg a Trick To Save His Kids $250M in Taxes

Posted on October 22, 2014 by admin

The Facebook, Twitter, LinkedIn founders saved their children about $1B in taxes. Zuckerberg, alone, saved about $250M in taxes. Long before their companies went public, they put a very small percentage of their stock in a Grantor Retained Annuity Trust (“GRAT”). A GRAT is a trust that works magnificently when the assets placed in it appreciate over the term of the GRAT (usually about 3 to 15 years).

The key rule with a GRAT is that you need to distribute to yourself about 102% of the initial value of the assets placed in the GRAT. Assume that you place 1M shares of stock in a 5 year GRAT when the price per share is $1 ($1M of stock) and the stock price increases by $50 per year. You will need to distribute to yourself annually about $204K ($1M initial value divided by 5 year term plus about 2% interest per year). So, at the end of the first year, you will distribute about 4,000 shares of stock, as those shares at that time would be worth about $204K. At the end of the 5 year term, there will be about 990K shares of stock remaining in the GRAT.

So, when you die, these asset pass to the beneficiaries of the GRAT (usually your children or future, yet-to-be-born children) tax free. So, if you die immediately after the term of the GRAT, the beneficiaries would receive about $198M of stock tax-free. Huge savings. If the stock was not in a GRAT, the Federal estate tax would be about $67M.

In Zuckerberg’s case, he initially set up his GRAT with 3 million+ shares in 2008, 4 years before Facebook’s IPO. This was when a share of Facebook was worth less than a dollar. After the IPO, the value of each share (which Zuckerberg will get to pass on gift/estate tax-free) in the GRAT grew at least one hundred fold, which will save the eventual beneficiaries hundreds of millions of dollars when it’s transferred to them.

This example is very simplified, as there are many other “moving parts” and there are professional fees to set up and maintain the GRAT that need to be considered. Bottom line, though, if the GRAT assets appreciate, this can save your children tons of money in taxes.

Interestingly, these GRATs are often called “Walton” GRATs. The Wal-Mart family won a 2000 Tax Court case that opened this door and made these trusts legal.

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

83(b) Elections For Dummies

Posted on August 27, 2012July 14, 2022 by admin

First, a few basics:

If you have stock options, you do not need to file an 83(b) Election Form, unless you exercised the option early.
If you purchased/received founder’s stock and there are no restrictions, such as vesting, you do not need to file an 83(b) Election Form.
If you purchased/received restricted stock in a growing startup, you should probably (about 99% of the time) file an 83(b) Election Form.

Here is why you want to file an 83(b) Election:

If you think the value of your stock will increase, you will NOT be forced to pay taxes on “phantom income” each year.

Let’s give an example to show the consequences of not filing an 83(b) election:

You own 10% of the stock of your startup. It vests over 4 years, or 25% per year.
You purchased this stock for $100 (fair market value) on January 1 of Year 1.
During Year 1, the Company raised some outside financing that values the company at $10M.
At the end of Year 1, the value of the Company is $10M and the value of your stock is worth $1M.
You have about $250K in taxable income in Year 1 ( [value of Company at year-end, $10M less value of Company at beginning of year, $1K] * ownership percentage, 10% * vesting % in Year 1, 25%).
You owe about $100K in Federal and State taxes.
You will pick up additional taxable income in Year 2 through Year 4 if the value of the startup continues to increase.
You do not get any tax relief if the value of the Company decreases.
Remember, this “phantom income” is triggered just by the value of the Company increasing – not by exercising the options or selling the stock.

Here is how to file an 83(b) election:

Download the Sample 83(b) Election Form and Letter below.
Sign the 83(b) Election Form and letter and follow the instructions in the letter.
Mail the letter and 83(b) Election Form to the IRS address (see dropdown below for address) within 30 days after the stock grant (there is no relief if you file late).
Mail Certified Return Receipt Requested to prove timely delivery.
If you live in a community property state, your spouse also needs to sign the 83(b) Election Form.
Give a copy of the signed 83(b) Election Form to the Company.

SAMPLE SECTION 83(b) ELECTION FORM:

SAMPLE TRANSMITTAL LETTER TO IRS:

Enclosures

WHERE TO MAIL THE LETTER AND 83(b) ELECTION FORM TO:

Before mailing, check the IRS instructions for Form 1040 and/or consult your tax advisor to ensure the addresses below are still valid as the IRS occasionally changes mailing addresses.

If you live in…	Mail to:
Alabama, Arkansas, Connecticut, Delaware, District of Columbia, Georgia, Illinois, Indiana, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Missouri, New Hampshire, New Jersey, New York, North Carolina, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, West Virginia, Wisconsin	Department of the Treasury Internal Revenue Service Kansas City, MO 64999-0002
Arizona, Florida, Louisiana, Mississippi, New Mexico, Texas	Department of the Treasury Internal Revenue Service Austin, TX 73301-0002
Alaska, California, Colorado, Hawaii, Idaho, Kansas, Michigan, Montana, Nebraska, Nevada, North Dakota, Ohio, Oregon, South Dakota, Utah, Washington, Wyoming	Department of the Treasury Internal Revenue Service Ogden, UT 84201-0002
A foreign country, U.S. possession or territory,* or use an APO or FPO address, or file Form 2555 or 4563, or are a dual-status alien.	Department of the Treasury Internal Revenue Service Austin, TX 73301-0215
*If you live in American Samoa, Puerto Rico, Guam, the U.S. Virgin Islands, or the Northern Mariana Islands, see Pub 570.

IRS Circular 230 Disclosure

How to Negotiate your Equity Compensation in VC-Backed Startups

Posted on May 20, 2012 by admin

In our work at venture-backed startups, we are amazed at how hard new employees will negotiate pay, benefits, workspace, duties, titles, etc. and just totally accept their equity compensation.

So, we have prepared six questions that will make you look really smart and help you understand your equity compensation. It may also make you a lot richer when your Company is acquired.

Assumption: You have been offered an incentive stock option for 100,000 common stock shares at an exercise price of $0.05 per share that vests 25% after the first year and then monthly for the next three years.

Questions:

1. How many shares are outstanding on a fully-diluted basis?

2. Can I receive restricted stock, rather than incentive stock options?

3. Based on the current burn rate, when does the Company plan to raise the next round of equity?

4. Will the Company refresh when the next round is raised?

5. What is the liquidation preference that is in front of the common shares?

6. Is there any acceleration of vesting upon a change in control?

Analysis:

1. Your slice of the pie. Obviously, there is a huge difference in the size and value of your slice if the pie (total shares outstanding) is 1M shares vs. 100M shares. Fully-diluted just converts all preferred stock shares and warrants to common stock shares.

2. The answer will probably be no, but ask the question anyway. Restricted stock just means that you actually own the stock (vs. an option to purchase the stock) with restrictions (vesting schedule). It is a much better deal for taxes.

3. The answer to this is important, as it is a back-door way to ask when does the Company run out of money?

4. When the Company raises additional equity, they issue more shares, so the pie grows and your slice shrinks. This is just an intelligent sounding way to ask if they plan to make you whole by issuing you additional options. This is worth negotiating.

5. Preference is the amount paid to the investors when the Company is acquired, before any amount is paid to stockholders. It is often 1X which means if there was $10M invested in the Company, that amount (plus dividends) is the first money paid, before anything flows down to stockholders, including option holders.

6. Sometimes, companies will accelerate your unvested stock options upon an acquisition. This can be huge to negotiate if you anticipate an acquisition in the near future.

Good luck and remember if you have gotten to the point where there is an offer on the table, the Company wants you and this will be the best and maybe only time to negotiate your equity compensation.

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