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Jim Schneider
The Taxman86 Speaks...
20 June 2000
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We have good news and bad news; Today is the longest day of the year; Lawyers are doing well these days.

1. Venture Capital is still flowing.

The headlines about Venture Capital keep coming with the latest at $87M. Thats the good news, what is the bad, you asked? What happened to all the key employees' Incentive Stock Options [ISOs]? We asked back. Recently the media has been full of stories about the care and feeding of high tech employees, including those at our good friends Bigstep.com.

We have been told that equity is in, and that ISOs are the way to go. Does anyone understand the tax issues of ISOs or how about Non-qualified Stock Options [NQSOs], which are the ones that independent contractors, consultants, and other non employees get? We do not think there is much talk about this subject.

Suppose you are one of the key players and got your 100,000 share ISO exercisable at $.01 or $1,000 over four years, and know that if things go well we are looking at $15 to $20 IPO price and then $75 to $100 thereafter. Is this the real world for some, such as MP3.Com and others with the current price at or below the IPO price. WOW! what a ride, with the taxman looking very closely.

Did someone get the chance to sell some of their ISO stock? If so, did they wait for one year after the ISO was exercised? In many cases we think it was exercised then immediately sold, after the six month lock up period, and thus it may have been all ordinary income. With NQSO it is always ordinary income between the option price and fair market value when exercised.

For those that exercised their ISO [which is regular tax free] and held for the one year, how did you pay the Alternative Minimum Tax [AMT] on the spread between fair market value and the exercise price, which could be at 26%+?

Moreover, are you still holding that ISO while the company raised the additional $87M? If this is the case, you just lost out under IRC Section 1202 since you must be issued the common stock from a C Corp. with $50M or less in gross assets. Thats the bad news, no Qualified Small Business Stock [QSBS] under IRC Section 1202. Thus if you sell you do not get the chance to defer the gains under IRC Section 1045. Sounds pretty complicated to me? Well it is, unless you are one of those Silicon Valley law firms that got IRC Section 1045 put into the IRC in late 1997 [see below; they are always getting their stock issued when the company has less than $50M].

2. While the President Parties, Congress is at work.

Death Tax Repeal, Presciption Drug Benefits, Marriage Penalty, Campaign Disclosure, Surplus Lockups, and Distressed Communities legislation are all coming this week and next, with the Fourth of July holiday break to follow.

Check out Tax Analysts new Web Site, not bad for a Non Profit.

3. Legal fees are up says The Industry Standard.

How much does public offering [IPO] work cost these days, check with The Industry Standard; it is quiet expensive and not risk free. Could some of these dollars be paid for tax advice for the employees? Why not since the key employees are getting it. The following was sent to us from Industry Standard's e-mail on Net Law, enjoy.

"...DOLLARS AND SILICON: Silicon Valley tech law firms have lagged behind New York and Los Angeles in raising the fees they charge for transaction work, but they're catching up. The latest ploy is to levy 'premium rates' above and beyond their regular hourly billing rates.Securities and Exchange Commission documents show that Bay Area firms, in the recent past, collected an average of $420,000 for doing an IPO, New York lawyers take in $818,000 and L.A. firms get $663,000 on average..." (Paid subscription required.)

What is not mentioned is that many Silicon Valley law firms, more often then not, get to buy in [they do not take NQST] at the original VC prices and then enjoy capital gains from the IPOs, and then defer under IRC Section 1045. Maybe there is a message here, avoid NQSTs, as noted above and get in early.

Jim Schneider, LL.M.

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