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Old 01-11-2012, 08:37 AM   #41
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Originally Posted by MichaelB View Post
When an executive receives a stock option, it is usually "xxx number of shares, at today's closing price, good for 10 years."
On in the case of my old employer "xxx number of shares, at a price significantly higher than today's closing price, good for 10 years."

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Old 01-11-2012, 08:41 AM   #42
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Or in the case of many CEOs in the late 90's early 00's, "xxx number of shares, at the lowest price in the last year, good for 10 years."

Stack that deck...

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On in the case of my old employer "xxx number of shares, at a price significantly higher than today's closing price, good for 10 years."

Dangle that carrot...
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Old 01-11-2012, 08:42 AM   #43
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A stock option is the right to buy a specific number of shares at a fixed price. A stock grant is a "gift" of stock. When an executive receives a stock option, it is usually "xxx number of shares, at today's closing price, good for 10 years. It has value only if the price of stock increases. The executive is then able to buy the stock at the low "option" price and sell it for market price. Stock options are considered ordinary income when exercised, but there are well documented cases of senior execs setting up complex tax schemes that let them receive the cash value of the options without paying any tax.

A grant is a transfer of stock, usually restricted, meaning it "xxx number of shares, vesting 25% per year beginning in year 4, only if the individual is still employed'. The stock is considered ordinary income when it vests, and any change in price after that is a capital gain or loss.
Let me see if I understand. An option is only "an option" for the right to buy the stock at a set price at the time it is given. So..if the stock price goes down, the person probably would not exercise it..right? When exercised, is the entire value considered ordinary income? So if I was given 100 stock options and exercised them at a value 0f $10, I would have to log $1,000 as income on my tax return and pay ordinary income tax rates?
How do those set up ordinary tax schemes to avoid tax on transactions such as this? Routed to a tax deferred vehicle? Routing to a Charitable Remainder Trust? In one case tax will eventually be paid and in the other, a charity is getting the benefit. Wonder what other tax deferred or tax avoidance mechanisms are used.
With grants, do I assume that income tax is paid on the 25% that vest each of the 4 years? And that after that, if there is stock appreciation it is at the cap gain rate? So ..this doesn't sound any different from those of us who buy stocks, once the grant vest. The reverse is also true, right? There could be a loss.
It sounds to me that with both options and grants, the person at some point does pay ordinary income tax. So to say they are paying only 15% at this point is not entirely true? Correct me if I am wrong. It also sounds like options and grants can be directed to other mechanisms to either defer or avoid tax but not in manners that are any different than what each of us have available to us. They may be a bit more sophisticated but I think the government has put a damper on the off shore stuff haven't they?

Is there any scenario with options or grants where one does not pay "ordinary income tax rates" at some point..?

Thanks Michael B...
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Old 01-11-2012, 08:48 AM   #44
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There are different types of stock options that have different tax treatment.

Incentive stock options (ISO)--

You can get long term capital gains rates if all the conditions are met.

Non-qualified stock options (NSO)--

You always pay ordinary income rates

Here is a link--

What’s the difference between an ISO and an NSO? : Startup Company Lawyer



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Originally Posted by sheehs1 View Post
Let me see if I understand. An option is only "an option" for the right to buy the stock at a set price at the time it is given. So..if the stock price goes down, the person probably would not exercise it..right? When exercised, is the entire value considered ordinary income? So if I was given 100 stock options and exercised them at a value 0f $10, I would have to log $1,000 as income on my tax return and pay ordinary income tax rates?
How do those set up ordinary tax schemes to avoid tax on transactions such as this? Routed to a tax deferred vehicle? Routing to a Charitable Remainder Trust? In one case tax will eventually be paid and in the other, a charity is getting the benefit. Wonder what other tax deferred or tax avoidance mechanisms are used.
With grants, do I assume that income tax is paid on the 25% that vest each of the 4 years? And that after that, if there is stock appreciation it is at the cap gain rate? So ..this doesn't sound any different from those of us who buy stocks, once the grant vest. The reverse is also true, right? There could be a loss.
It sounds to me that with both options and grants, the person at some point does pay ordinary income tax. So to say they are paying only 15% at this point is not entirely true? Correct me if I am wrong. It also sounds like options and grants can be directed to other mechanisms to either defer or avoid tax but not in manners that are any different than what each of us ourselves have available to us. They may be a bit more sophisticated but I think the government has put a damper on the off shore stuff haven't they?

Is there any scenario with options or grants where one does not pay "ordinary income tax rates" at some point?

Thanks Michael B...
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Old 01-11-2012, 09:13 AM   #45
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How do those set up ordinary tax schemes to avoid tax on transactions such as this? Routed to a tax deferred vehicle? Routing to a Charitable Remainder Trust? In one case tax will eventually be paid and in the other, a charity is getting the benefit. Wonder what other tax deferred or tax avoidance mechanisms are used.
The most common method was to transfer the shares to a specially created trust, borrow an amount equal to the market value of the option shares and use the options as collateral, and let the lender take the shares plus appreciated option value. Very complex area, with some of the best and brightest minds continually looking for ways to enable schemes like this.

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With grants, do I assume that income tax is paid on the 25% that vest each of the 4 years? And that after that, if there is stock appreciation it is at the cap gain rate? So ..this doesn't sound any different from those of us who buy stocks, once the grant vest. The reverse is also true, right? There could be a loss.
Correct

Quote:
It sounds to me that with both options and grants, the person at some point does pay ordinary income tax. So to say they are paying only 15% at this point is not entirely true?
Yes, mostly, and it is a common misunderstanding.

Quote:
Correct me if I am wrong. It also sounds like options and grants can be directed to other mechanisms to either defer or avoid tax but not in manners that are any different than what each of us have available to us. They may be a bit more sophisticated but I think the government has put a damper on the off shore stuff haven't they?
I don’t understand the question

Quote:
Is there any scenario with options or grants where one does not pay "ordinary income tax rates" at some point..?
Corporate executives that receive stock based compensation are taxed as described above and pay income tax and medicare tax, but social security tax only within the yearly limits. Qualified stock options have a special tax treatment that give option recipients the option of paying lower, capital gains tax rates, but also have a unique tax risk and they are not generally being used any longer.

Also, as indicated previously, hedge funds and private equity funds, are taxed at capital gains tax rates even thought their compensation is “ordinary income”. Much of how executives are paid and taxed is poorly understood by the media, but that does not hold them back from spreading their message far and wide.
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Old 01-11-2012, 09:18 AM   #46
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There are different types of stock options that have different tax treatment.

Incentive stock options (ISO)--

You can get long term capital gains rates if all the conditions are met.

Non-qualified stock options (NSO)--

You always pay ordinary income rates

Here is a link--

What’s the difference between an ISO and an NSO? : Startup Company Lawyer
Thanks Hamlet. Interesting. So regardless at some point, ordinary income tax is paid on a stock option or grant. I get that the stock price can be manipulated or that the CEO may get it at a low set point..etc. but that doesn't seem to be anyones business. He/she will,at some point, pay ordinary income tax or give it to charity to get a tax deduction or whatever.

It is also relevant that whether it be an option or a grant, it carries the risk of loss. (Enron).

Is part of the argument then that a LARGE part of CEO income "could be" in these options/grants...so that eventually a LARGE part of their net worth, "once they have paid ordinary income tax on the option/grant..." is then subject only to the 15% cap gains or dividends on the growth of that basis?
But the point is well taken that at some point that did pay the ordinary tax rate.

How is this any different from anyone who inherits 2 million in cash (or less) and doesn't pay tax on it since the Unified Tax Credit is 3 million, chooses to invest it and only pays the 15% from that point forward?

So one point of the argument isn't really about stock options and grants ...is it? It is about anyone that accumulated "something", paid their fair share of ordinary income tax and is now taxed at 15%.

Sounds to me the like government and the current rhetoric is VERY short sited. If one looks at this in terms of "a curve", then one can make the argument that they are trying to "speed up" what they would get anyway over 1 to 30 years, in a sense. Speed it up AND get more. But it is the "get more" part that could back fire. They are trying to shorten the tax curve. Fair statement or not? Could this not lead to there being "less" in tax revenues down the road? If they take more now, then there possibly will be less to generate that revenue later. ummmmm....

Either that...or it is simply being used as a political tool, as a running platform or to deliberately shake things up.
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Old 01-11-2012, 09:21 AM   #47
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Thanks for making me back off. I agree there are lots of different situations here and I'm glad I didn't get picked to figure out a fair tax system. However, in my ignorance such as it is, I don't understand why I should pay 28% income tax on IRA/401K withdrawls and rental income and my pension when others pay 15%. Help a guy out here.

One thing I will say is that I'd rather have income being taxed at 28% and have more of it than not have it at all.
OK. Lets look at two people with cap gains, and this scenario can happen on any given day:

Person A buys $X worth of stock. Two years later, it is worth 1.1X. He sells and owes a 15% tax on the 10% gain.

Person B buys $X worth of stock. Twenty years later, it is worth 1.1X. He sells and owes a 15% tax on the 10% gain.

For Person A, inflation over the two years would have been ~ 6% (assume 3% average 1.03^2 ~ 1.06), so that 10% gain only looks like ~ 4% gain in buying power.

For Person B, inflation over the twenty years would have been ~ 80% (1.03^20 ~ 1.8), so that 10% 'gain' is a loss in buying power. He would need 1.8X just to keep up and claim an actual 'profit' over inflation. But he has only 1.1X, that's a big loss. Yet, he is taxed the same as A, and almost the same as someone making income in the present year.


You are right, it isn't fair - we should eliminate cap gains tax, not just reduce it.

All this talk about defining income takes me back to the National Sales Tax approach. I actually do think that would be best. Tax what you spend, it takes away all the complexity of where, when and how you made the money. It captures illegal income, too. The very few rich people who are not spending accordingly probably aren't earning a lot of currently taxable income anyhow, so I don't think that's a big deal.

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Old 01-11-2012, 09:23 AM   #48
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There are different types of stock options that have different tax treatment.

Incentive stock options (ISO)--

You can get long term capital gains rates if all the conditions are met.

Non-qualified stock options (NSO)--

You always pay ordinary income rates
Thanks, Hamlet. That clears it up.

Rather than implement a whole new tax with all its unintended consequences, why not simply close that particular loophole in the tax code?
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Old 01-11-2012, 09:30 AM   #49
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So if I am to believe that I understand what was posted by MichaelB Hamlet and Sheehs1 then the vast majority of compensation is taxed at the same rates I pay and not at cap gains. Correct?
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Old 01-11-2012, 09:33 AM   #50
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This article should serve to remind us how lucky we LBYMers are that we often fall below the radar on tax issues. For example,
paying almost no tax on large Roth conversions.
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Old 01-11-2012, 09:39 AM   #51
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So if I am to believe that I understand what was posted by MichaelB Hamlet and Sheehs1 then the vast majority of compensation is taxed at the same rates I pay and not at cap gains. Correct?
Correct RetireBy90. At some point, ordinary income tax rates are paid either when the grant invests or when the options are exercised. I'm not saying the CEO might not get a lower set point or price for execution...but they will eventually pay ordinary income tax rates.

However, the hedge fund managers and the private equity partners...might be a different story. I'm also not well versed in how they are paid. We could get into that one too for an increased understanding...if there is anyone on the board who falls into these categories who is willing to share the information
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Old 01-11-2012, 09:54 AM   #52
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Well, ISO options can be taxed at long term capital gains rates, but as someone else said, they are becoming uncommon.

The big issue with options in the past was that CEO's were often getting them backdated to the lowest possible price in the grant period. It essentially amounted to stealing from shareholders, but I believe that practice has been put to a stop.

The hedge fund managers are getting a special deal that is completely immoral, IMO. They've bought a loophole from our Congress critters to allow them to essentially pay 15% rates on their ordinary income.

I don't think most CEO's are under-taxed. Overpaid maybe, but not under-taxed

I think the childeren of Sam Walton are under-taxed though. This idea that the owners of capital should get a free ride tax-wise is ridiculous, IMO.

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Correct RetireBy90. At some point, ordinary income tax rates are paid either when the grant invests or when the options are exercised. I'm not saying the CEO might not get a lower set point or price for execution...but they will eventually pay ordinary income tax rates.

However, the hedge fund managers and the private equity partners...might be a different story. I'm also not well versed in how they are paid. We could get into that one too for an increased understanding...if there is anyone on the board who falls into these categories who is willing to share the information
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Old 01-11-2012, 10:07 AM   #53
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Thanks Hamlet. Interesting. So regardless at some point, ordinary income tax is paid on a stock option or grant. I get that the stock price can be manipulated or that the CEO may get it at a low set point..etc. but that doesn't seem to be anyones business. He/she will,at some point, pay ordinary income tax or give it to charity to get a tax deduction or whatever.

It is also relevant that whether it be an option or a grant, it carries the risk of loss. (Enron).

Is part of the argument then that a LARGE part of CEO income "could be" in these options/grants...so that eventually a LARGE part of their net worth, "once they have paid ordinary income tax on the option/grant..." is then subject only to the 15% cap gains or dividends on the growth of that basis?
But the point is well taken that at some point that did pay the ordinary tax rate.

How is this any different from anyone who inherits 2 million in cash (or less) and doesn't pay tax on it since the Unified Tax Credit is 3 million, chooses to invest it and only pays the 15% from that point forward?

So one point of the argument isn't really about stock options and grants ...is it? It is about anyone that accumulated "something", paid their fair share of ordinary income tax and is now taxed at 15%.

Sounds to me the like government and the current rhetoric is VERY short sited. If one looks at this in terms of "a curve", then one can make the argument that they are trying to "speed up" what they would get anyway over 1 to 30 years, in a sense. Speed it up AND get more. But it is the "get more" part that could back fire. They are trying to shorten the tax curve. Fair statement or not? Could this not lead to there being "less" in tax revenues down the road? If they take more now, then there possibly will be less to generate that revenue later. ummmmm....

Either that...or it is simply being used as a political tool, as a running platform or to deliberately shake things up.

Just want to make a point... if you have a option, there is no risk of loss.. if the price to exercise them is higher than the current price, like mine that are about to expire, you just do not exercise them and they disappear... I lose nothing except for the HOPE they would have value...

As for the stock grant, you do have the chance of losing... but if the value goes down before you get the stock, then your taxes are also lower... I only got a grant once and it was for only a few shares so not worth much (maybe $1,000)... but I did not pay that much attention to the taxability of them so I could be off a bit...


Edit to add: The reason that stock options and stock grants are used is that most of the time the stock value goes up... and with some companies up a LOT... so if the company does well, the employee does well... think Microsoft, Dell, (way back when) Google, Facebook (now) etc. etc... it means your final compensation can be a whole lot higher than what the company could afford paying cash...
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Old 01-11-2012, 10:15 AM   #54
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Just want to make a point... if you have a option, there is no risk of loss.. if the price to exercise them is higher than the current price, like mine that are about to expire, you just do not exercise them and they disappear... I lose nothing except for the HOPE they would have value...

As for the stock grant, you do have the chance of losing... but if the value goes down before you get the stock, then your taxes are also lower... I only got a grant once and it was for only a few shares so not worth much (maybe $1,000)... but I did not pay that much attention to the taxability of them so I could be off a bit...
But Texas Proud...didn't you loose "the bonus" that was given in options.? While you may not actually have lost on a tax basis or income basis, if you were given them in lieu of a bonus...didn't you loose? If the bonus had been paid in cash you wouldn't have lost.
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Old 01-11-2012, 10:22 AM   #55
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But Texas Proud...didn't you loose "the bonus" that was given in options.? While you may not actually have lost on a tax basis or income basis, if you were given them in lieu of a bonus...didn't you loose? If the bonus had been paid in cash you wouldn't have lost.

Except for that one stock grant that was not worth much, the options I got were given to all employees.... it was not a bonus... My bonus was all cash as I was not in the upper ranks, but a low level slave...

But I do see your point...
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Old 01-11-2012, 10:27 AM   #56
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Hedge fund and private equity managers compensation is conceptually different. The investment funds they manage are illiquid partnerships, and their primary pay is a share of profits, which is credited in their name to the fund they manage, so their pay is considered not salary but investment income, and it is taxed when they withdraw it from the fund, not when it is credited, at capital gains rates. It's a great deal if you can get it.

Do CEO's pay ordinary income taxes on all their stock based compensation? It is not possible to know, because we only learn of the tax avoidance schemes after they are successfully challenged by the IRS. Up to that point, they are confidential and few people know. What we do know is the cost to set up a tax scheme: >$1M. It needs a tax account to conceive it, a tax lawyer to review and approve it, and a broker or financial intermediary to set up accounts. Just the idea may be worth >$1M. It also requires the collaboration of the corporation granting the options or stock, because they must be transferable, which is not at all common. This is much more prevalent where the executive has an unusual amount of influence over the board: a family founded corporation, a founding CEO, or a tyrant. Or a spineless BoD. Personally, I do not believe most corporate executives or most corporate executive compensation engage in these practices.
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Old 01-11-2012, 11:06 AM   #57
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I'm facinated that people are willing to pay hedge fund managers the way they do.

It's pretty typical that a manager gets 2% of the assets and 20% of any profits. That's a payment scheme that encourages extreme risk-taking.

Imagine that I'm a hedge fund manager with $100 million under management.
If I employ a sensible strategy that nets me a consistent 10% return, I will make $4.2 million for that year.

If I take that money and wager it on a hand of blackjack, my expected pay is $12 million dollars ($24 million if I win the bet, $0 if I lose).

If I take that money and wager it on a single number in roulette, my expected pay is $19.7 million ($750 million if I win the bet (1 in 38 times), $0 if I lose).

I am better off taking a terrible gamble in the hope of a huge payoff than investing sensibly.


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Hedge fund and private equity managers compensation is conceptually different. The investment funds they manage are illiquid partnerships, and their primary pay is a share of profits, which is credited in their name to the fund they manage, so their pay is considered not salary but investment income, and it is taxed when they withdraw it from the fund, not when it is credited, at capital gains rates. It's a great deal if you can get it.

Do CEO's pay ordinary income taxes on all their stock based compensation? It is not possible to know, because we only learn of the tax avoidance schemes after they are successfully challenged by the IRS. Up to that point, they are confidential and few people know. What we do know is the cost to set up a tax scheme: >$1M. It needs a tax account to conceive it, a tax lawyer to review and approve it, and a broker or financial intermediary to set up accounts. Just the idea may be worth >$1M. It also requires the collaboration of the corporation granting the options or stock, because they must be transferable, which is not at all common. This is much more prevalent where the executive has an unusual amount of influence over the board: a family founded corporation, a founding CEO, or a tyrant. Or a spineless BoD. Personally, I do not believe most corporate executives or most corporate executive compensation engage in these practices.
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Old 01-11-2012, 11:36 AM   #58
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Hedge fund and private equity managers compensation is conceptually different. The investment funds they manage are illiquid partnerships, and their primary pay is a share of profits, which is credited in their name to the fund they manage, so their pay is considered not salary but investment income, and it is taxed when they withdraw it from the fund, not when it is credited, at capital gains rates. It's a great deal if you can get it.

Do CEO's pay ordinary income taxes on all their stock based compensation? It is not possible to know, because we only learn of the tax avoidance schemes after they are successfully challenged by the IRS. Up to that point, they are confidential and few people know. What we do know is the cost to set up a tax scheme: >$1M. It needs a tax account to conceive it, a tax lawyer to review and approve it, and a broker or financial intermediary to set up accounts. Just the idea may be worth >$1M. It also requires the collaboration of the corporation granting the options or stock, because they must be transferable, which is not at all common. This is much more prevalent where the executive has an unusual amount of influence over the board: a family founded corporation, a founding CEO, or a tyrant. Or a spineless BoD. Personally, I do not believe most corporate executives or most corporate executive compensation engage in these practices.
To address the hedge fund and private equity partners, that is a good deal if you can get it.

Interesting that profits are characterized differently for hedge funds/private equity"partnerships" than for C corps or Sub S companies in the private sector. Owners of C corp companies can be taxed twice. Once at the corporate rate for what is sitting on the profit line. If they declare a dividend to owners, then it is taxed again at their individual rate.

This is the reason most small companies prefer S Corp status. The same money is only taxed once. S corp owners owe all tax due the Federal and State governments at their individual ordinary income tax rate. The corporation does not pay the tax.

But I also see in the case of hedge funds/private equity WHY "that profit" may be considered investment income, since it is "routed" back to the hedge fund/private equity firm and conceivably to strengthen the investment and not weaken it. I see where it may get a bit "grey" here. The owner does not or may not have control over how the money is routed, how it is titled..etc. It might be credited in his name but the fund may still be the owner until it is exercised. Don't know. Along this route, it sounds like it may not go into his hands directly such that he has a "personal" decision he can make about the funds. And perhaps that is why it is not characterized as ordinary income. Don't know.

And I am fairly confident there are internal rules and regulations about how much they can take out and when.

However, if no piece of this is EVER taxed at ordinary tax rates, this is a point I can disagree with and agree that at some point, the basis should be taxed at ordinary tax rates.

Is this something unique to hedge funds and private equity firms or is it unique to the "partnership designation? Do private sector partnerships also enjoy this re-characterization of profits from "profits" typically associated with ordinary income taxation to "investment" designation?
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Old 01-11-2012, 02:04 PM   #59
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The logic behind taxing private equity and hedge funds as investment income is that the owners were the partners, so they were investing their own money, along with that of others. It did not view fund managers as employees receiving compensation. When private equity and hedge funds evolved into broad based investments opportunities with fund managers investing other people's money, the tax code was not updated to make the distinction. This is a true "loophole".

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And I am fairly confident there are internal rules and regulations about how much they can take out and when.
I do not share your confidence.

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Is this something unique to hedge funds and private equity firms or is it unique to the "partnership designation? Do private sector partnerships also enjoy this re-characterization of profits from "profits" typically associated with ordinary income taxation to "investment" designation?
Carried interest is pretty specific to private equity and hedge funds. Partnerships in general are subject to complex tax regulations, but there is a clearer distinction between general partners, who really are investors, and senior partners, who may be investors but are also employee managers.
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Old 01-11-2012, 02:37 PM   #60
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Originally Posted by Texas Proud View Post
Just want to make a point... if you have a option, there is no risk of loss.. if the price to exercise them is higher than the current price, like mine that are about to expire, you just do not exercise them and they disappear... I lose nothing except for the HOPE they would have value...

As for the stock grant, you do have the chance of losing... but if the value goes down before you get the stock, then your taxes are also lower... I only got a grant once and it was for only a few shares so not worth much (maybe $1,000)... but I did not pay that much attention to the taxability of them so I could be off a bit...


Edit to add: The reason that stock options and stock grants are used is that most of the time the stock value goes up... and with some companies up a LOT... so if the company does well, the employee does well... think Microsoft, Dell, (way back when) Google, Facebook (now) etc. etc... it means your final compensation can be a whole lot higher than what the company could afford paying cash...
Texas Proud quote - Except for that one stock grant that was not worth much, the options I got were given to all employees.... it was not a bonus... My bonus was all cash as I was not in the upper ranks, but a low level slave...

But I do see your point... quote





My situation was the "worst" of both worlds. My Megacorp had "promised" us a 50% match on our 401(k)s but almost always gave us 100% match (in the good old days). When Megacorp fell on hard times, they temporarily did away with ALL match and gave us future stock options "instead". This happened several times (sometimes they did away with the "bonus" which was actually just a "hold-back" of our compensation). Unfortunately, not one of the options was EVER in the money. Even though the employees took significant hits (either "bonus" or match) they never saw a penny from the options. Very good deal for Megacorp. Other than the paperwork (and maybe a "little" employee good will) it cost them nothing. But, I'm not bitter!
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