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Jim Schneider
The Taxman86 Speaks...
21 August 2000
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Lets Hear It For Old Man River; Good Employees Are Hard To Come By; Stock Options Just Do Not Cut It.

1. The Mississippi River goes a long way and is great for tax policy but maybe Austin is where it is happening.

The Vice President loves the details, and apparently loves to debate tax policy on the Riverboat Mark Twain. Maybe that is why the House Speaker wants a truce, with pension reform and distressed communities the chosen ones to be passed this year.

The Mississippi Delta Region has been depressed for a long time, with the President and the Vice President deeply involved for over 10 or more years. Now comes S. 2936 "Creating New Markets and Empowering America Act of 2000" [the "Act"] and TITLE VIII-- DELTA REGIONAL AUTHORITY, which will set up another new economic aid program for the region. Keep those grants rolling with the river. The issue is a timely one.

To compliment that effort, and a better approach say some, would be to expand the Capital Gains Roll Over and Exclusion provisions [Sections 406 and 407 of the Act] for Empowerment Zone Investments to include Enterprise Community Investments, and thus pick up 95 Enterprise Communities, including the North Delta Mississippi Enterprise Community, the Memphis Enterprise Community, and the New Orleans Enterprise Community among others.

It would be pretty exciting to see all that music, culture and beauty on the Internet, live and in color, with the New Economy coming to the Delta. If you think idea that is ahead of its time we suggest you read the latest Special Report by The Industry Standard on Entertainment, or Apple's Quicktime or better yet see this one. This is the future, and the future is now. All for under several thousands of dollars for professional equipment in a home-based business.

Will the VCs buy into that program? We think so, if they can get out of the Silicon Valley long enough to smell the roses.

And, based on the New York Times Magazine it is happening in the poorest sections of Austin Texas. "...Howton looked at what was happening in Austin and decided to start classes in C++ and Java computer languages, and set up a multimedia lab where students build Web sites. (They were doing one for the L.B.J. ranch when I visited.) She filled classrooms with orange and aqua i-Macs, got every kid an e-mail address and wired up the shabby brick building with fiber-optic lines. She marched me down the hallway to show me the black Novell servers stacked in an old janitor's closet. It's a blinking, glowing declaration of progress where you'd least expect to find it. Since the servers were installed, there have been no gang problems at Travis..."

2. Good employees require special benefits, including!!!

If you want to get the flavor of how competitive the labor market is in San Francisco, the New Media Capital of the World, say some, including George Lucas, check out the print copy of The Industry Standard or their web site to see what they have to offer by way of fringe benefits, including Twice-Weekly In-House Massage, Late-Night Car Service, financial planning, among other things.

We suggest a better approach, and that is to provide tax free meals and lodging, including maid service, laundry, food to go, and a fully equipped high tech facility, including a game room, etc. Put that housing in the San Francisco Enterprise Community and make it part of the Business Premises and see what happens to the potential Equity Kickers given to those same employees. See below. It is called Animal House meets the VCs.

If you want to see where these areas just might be we suggest you check out the locator: including the Santa Ana Empowerment Zone which is five minutes from South Coast Plaza and the John Wayne Airport, ten minutes from Fashion Isle in Newport Beach, and is surrounded by the Tech Coast crowd.

3. Stock Options vs. Restricted Stock vs. Interests in LLCs.

Qualified and non qualified stock options have been around a very long time, but it was not until 1986, with the advent of the Alternative Minimum Tax that things became complicated. The potential capital gains, if the optioned stock is held one-year or more is illusory we are told, and that most employees will sell immediately after it becomes vested [thats great for the employer who gets an ordinary deduction equal to the ordinary income] and will be subject to withholding taxes in many cases.

In 1993 and 1997 the concept of lower capital gains for Qualified Small Business Stock [QSBS] under IRC Section 1202, if held five years or more, became available, and the capital gains roll over after six months under IRC Section 1045. However, the QSBS must be acquired from the issuer when it has $50M or less in gross assets, which may not be the case if it has just gone public, or if it is ordinary income and not capital gains [sold within one- year].

What is the better approach?

California and other states allow a corporation to issue stock in exchange for promissory notes if it is sold to employees pursuant to a stock purchase plan. The holding period on that stock, commonly known as Restricted Stock, begins immediately, even if there are buy back restrictions similar to a stock option agreement. The best result is that this restrictive stock is not subject to the statutory non assignment rules of stock options and thus could be given in trust to family members, etc.

What is the best approach?

Interests in a Limited Liability Company [LLC], which is treated as a partnership for tax purposes may be the best of all worlds. If the LLC is generating losses, as may be the case with startups, these losses may be used by the employees to cover their salaries.

If the LLC happens to be in an Empowerment Zone or possibly in an Enterprise Community then the gains from the sale of those LLC interests, which would include the earlier losses, will probably be capital gains, and if so then it appears that these capital gains, if the LLC interests are held for one-year or more, are subject to the roll over under proposed IRC Section 1397B. In short, it would appear that the New Economy may in fact be coming to the distressed neighborhoods just as President Clinton suggested in his speech [twice we were told] last week to the nation. And if the employer throws in affordable housing, and other benefits, as suggested by the Vice President, then thats all the better for the 'middle class'.

Jim Schneider, LL.M.

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