President Biden’s expected proposal to double the U.S. capital gains tax rate, part of his $4 trillion economic plan for reshaping the American economy, is significant for the U.S. startup and venture capital sectors, but the proposed hike likely wouldn’t affect the average employee at a venture-backed startup.
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Biden will propose increasing the capital gains tax rate for high-income earners from 20 percent to 39.6 percent, Bloomberg reported on Thursday. The proposal would affect people who earn $1 million or more and the federal tax rate for high-income investors could reach 43.4 percent (that’s the current surtax on investment income, plus the new capital gains tax rate), per Bloomberg.
“It’s a decent size number but I think it’s a pretty small percent that are falling north of that $1 million gross income threshold,” said David Snider, CEO of Harness Wealth, a New York-based tax firm that specializes in advising people with equity-based compensation. “At least as it’s been reported so far, this would only impact people who are above that threshold.”
The proposed tax hike could potentially spur more secondary offerings, if startup founders decide to cash out earlier in order to receive a better tax rate before the company becomes more valuable.
According to Vanessa Kruze, CEO and founder of Kruze Consulting, a capital gains tax hike could spark a “flurry of stock sales as startup founders and employees sell their stock prior to the new tax rates in order to avoid higher capital gains taxation.”
There could also be a decrease in angel investing as startup investing is seen as less attractive because of the new capital gains tax rate, Kruze said in an emailed statement.
Some investors expressed concern over the proposed tax hike, with venture capitalist Tim Draper tweeting that the proposed tax hike “might kill the golden goose that is America/Silicon Valley” and “spells death to job creation.”
But startup founders and early executives are more likely to be affected by the proposal than other employees, according to Snider.
“It tends to be a smaller population of the employee base that has exercisable equity and chooses to do so because very often they’re not people with tremendous cash balances who are willing to invest cash in a speculative company when it’s (unclear) when they’ll be able to sell,” Snider said.
The one caveat so far is there haven’t been any conversations about Section 1202, the small business stock gains exclusion. The Section 1202 provision allows the capital gains of those who invest in a company that has less than $50 million in assets or hold assets in that company before it crosses the $50 million threshold to be exempt from federal tax. For an individual, typically up to $10 million in capital gains is exempt.
Equity holders fall into four categories: the earliest typically own restricted stock, which faces capital gains after 12 months. Other employees have incentive stock options (ISOs), which have the benefit of no taxes owed when exercising as long as the holder is below the alternative-minimum tax amount. Those employees who have non-qualified stock options owe taxes when they exercise their options, and those who hold restricted stock options pay ordinary income tax no matter what, unless the company goes public.
Different types of stockholders would be affected in different ways by Biden’s proposal. But either way, stockholders may want to talk to a tax professional, Snider said.
“I think for the vast majority of readers, they shouldn’t panic and be selling stock or doing things in their account if they’re not consistently above $1 million in income anyways, and for those it (does apply to), take more to think through,” he said.
Illustration: Dom Guzman
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