TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, February 1, 2012

Polsky Presents The Tax Advantage of Founder’s Stock Today at Duke

PolskyGregg D. Polsky (North Carolina) presents Examining the Tax Advantage of Founder’s Stock, 97 Iowa L. Rev. ___ (2012) (with Brant J. Hellwig (South Carolina)), at Duke today as part of its Tax Policy Seminar hosted by Lawrence A. Zelenak.

Recent commentary has described founders' stock as tax-advantaged because it converts founders' compensation income into capital gains. In this paper we describe various founders' stock strategies that offer this character conversion and then analyze whether they are, on the whole, tax advantageous. While the founders' stock strategies favorably convert the charcter of the founders' income, they simultaneously turn the company's compensation deductions into non-deductions. Whether founders' stock is tax-advantaged overall depends on whethe benefit of the founders' character conversion outweighs the cost of the company's lost deductions. We use various hypoheticals to illustrate this tradeoff. We conclude that founders' stock is likely to be significantly tax-advantaged only in those cases where the startup company shows great promise early on but ultimately never develops into a profitable enterprise.

Even in that subset of cases where founders' turns out to be tax-advantaged, the advantage exists only because of the tax law's overly harsh treatment of net operating losses. Therefore, whatever tax-advantage that exists for founders' 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.

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