If you work at a startup company or have startup clients, you know all too well that cash can be tight and hiring and retaining top talent is a challenge. 

In response many startups turn to equity compensation to attract and retain top talent without breaking the budget on salaries and benefits. Stock-based compensation also ties employees to the company’s success as they essentially become owners. Employees will theoretically work harder and think twice before leaving if they have a chance to earn a substantial windfall in exchange for taking a below-market starting salary.

Great. But founders and their financial teams must remember that equity compensation is not free — it’s a form of deferred compensation that must be treated as an expense. As such, equity compensation has strict rules and regulations for employers and employees to follow, especially regarding taxes. 

Even with substantial financial backing, many private/early-stage companies do not have enough resources to handle complex GAAP accounting and financial reporting for SBC awards. This can be problematic since larger investors or banks typically want a third party to sign off on the accuracy of the startup’s financials. They want assurances that the company is not doing anything fraudulent or failing to follow GAAP guidance. Also, being careless with SBC in your company’s early years can make it very costly and time-consuming to change from non-GAAP to GAAP standards as you prepare for an IPO, sale or other exit.

Setting the table

One of the top requirements is to determine fair market value for the company’s stock through a 409(a) valuation, which is required for tax compliance and necessary before optioning or issuing stocks. Typically, startups will need to undergo the 409(a) valuation once per year and any time after they raise funding. Companies should also provide reasonable guidance to employees about the tax consequences of various types of equity compensation. That’s very important since some employees, particularly young workers, have never received equity compensation before. When restricted stock awards provide ownership interest upon vesting, the 83(b) election allows these awards to be taxed at the grant date based on their FMV — even if they have not fully vested. By making an irrevocable 83(b) election within 30 days of the RSA grant, employees recognize taxable income immediately without waiting for vesting. This strategy can be beneficial if the stock’s value is expected to rise, since it minimizes ordinary income and maximizes capital gains upon sale. However, employees and their advisors should be cautious because taxes paid via this election are non-refundable if the RSA does not vest, or if its value declines. Generally, paying tax upfront is advantageous when the stock’s value is lower.

Five things that founders and financial teams often overlook regarding equity compensation

1. Being too generous: Founders might want to understand various types of share-based payment awards, such as stock options, restricted stock awards, restricted stock units, etc., that best align with the company’s expected growth and strategies. They might unintentionally give out too many shares in employee equity plans without taking into account long-term equity dilution. Without careful planning, founders could inadvertently allow employees to receive more financial benefits than the company planned for in a liquidity event. Also, the founders might not have enough shares to give up in later rounds of financing.

2. Vesting criteria too easy to meet: Share-based payment awards come with various vesting conditions, with a plain vanilla plan being a four-year service vesting requirement without other performance conditions or without taking market conditions into account. Founders and their financial teams may want to provide employees with additional conditions if the vesting conditions are easy to achieve. Otherwise, key employees might leave the company much sooner than expected. I’ve found over my career that the easier the vesting conditions, the less motivation employees tend to have to perform at a high level and attrition rates rise.

3. Vesting criteria too aggressive: Conversely, if the employer wants to make vesting more stringent or restrictive, it can add conditions such as EBITDA targets or IPO/change in control, which are considered performance conditions, or multiple of invested capital, which is a market condition. Stock-based compensation awards serve as incentives. Vesting conditions should be challenging enough to drive employees toward meaningful, but not unrealistic, achievement. If vesting goals are set too high, the awards may lose their motivational effect, working against their primary purpose of aligning employee efforts with company success.

4. Inconsistent record keeping: The executive team sometimes underestimates the amount of effort required to maintain legal documents, the cap table, vesting and exercising schedules. Good recordkeeping is crucial when the company goes through financial statement audits or financial due diligence. Without proper recordkeeping, financial statement audits and due diligence processes can be significantly prolonged. This can trigger higher audit and diligence fees, delays in closing the transaction, and even risking deal termination or substantial penalties (see the cautionary tale below).

5. Tax implications: The founders might overlook potential implications of income taxes and payroll taxes varying depending on the types of awards. Understanding the main differences between incentive stock options and non-qualified stock options is essential when creating equity incentive plans.

Accounting challenges regarding common forms of equity compensation

Startups frequently use equity compensation (e.g., stock options, restricted stock units, etc.), but many fail to grasp its accounting complexities. ASC 718 requires companies to recognize the FMV of these awards as an expense. Complexities arise with performance-based or market-based conditions, which require careful classification and tracking. Accountants must ensure that awards (liability or equity) are properly classified and they must monitor modifications that could lead to additional expenses.

Misclassifying these instruments above can result in misstated financial statements, which is especially problematic during audits or liquidity events (e.g., M&A, IPO). Failing to account properly for embedded derivatives or misclassifying equity and liabilities can lead to noncompliance with GAAP, potential penalties and loss of investor confidence. 

Cautionary tale

One of our startup clients initiated their first financial statement audit to prepare for a Series A capital raise. They expected to complete the audit within eight to ten weeks, which is typical for companies with adequate staffing and strong internal controls. However, the audit dragged on for over a year due to significant recordkeeping issues. The company lacked a cap table, despite issuing multiple classes of preferred equity, stock options, restricted stock units, restricted stock awards, convertible debt, SAFEs and warrants. Some equity awards had even been granted without board approval. Reconstructing the cap table required extensive time from the management team, causing substantial delays.

After completing the cap table, the company engaged a third-party consultant to determine the appropriate accounting treatment for these equity instruments under ASC 718, ASC 480 and ASC 815 — a process that took additional weeks. In the tighter capital environment of 2022 to 2024 marked by higher interest rates, the company ultimately failed to secure the necessary working capital to sustain operations. Furthermore, due to poor recordkeeping, the company was required to amend prior-year tax returns, resulting in hefty penalties.

This case underscores the importance of maintaining accurate records and clear internal controls to avoid costly delays and risks during audits and capital-raising efforts.

Equity compensation is one of the most important tools startups have for preserving cash flow and retaining top talent. As a CPA, you play a critical advisory role in ensuring the company accounts for these instruments correctly, reducing the risk of costly restatements and ensuring compliance during future liquidity events. The startup culture runs fast and furious with constant pivots and reiterations. Don’t let proper treatment of equity compensation get lost in all the excitement. That’s where you come in.

The Republican sweep of the presidency and Congress has transformed what could have been a struggle to merely renew Donald Trump’s tax cuts into a multipronged campaign to slash levies in new and bigger ways.

The incoming Republican majorities in the House and Senate mean Trump can enact a tax bill without making concessions to Democrats. Republicans will only be constrained by how much deficit spending the party’s lawmakers and global financial markets can tolerate.

“That is the several trillion-dollar question,” said Rohit Kumar, co-leader of PwC’s national tax office and a former tax policy advisor to Senate Republican leader Mitch McConnell. 

Ian Maule/Getty Images

Owners of closely held companies and high-net worth families stand to benefit with Congress now more likely to renew expiring provisions in the 2017 law providing a 20% deduction on pass-through business income and an elevated estate tax exemption, said Gordon Gray, a former Republican Senate Budget Committee aide and now executive director of the Pinpoint Policy Institute.

Many Democrats campaigned on a tax-the-rich agenda and advocated paying for other tax cuts by targeting those provisions, as well as rolling back the law’s tax cuts for corporations and individuals making more than $400,000 per year.

Republicans’ election success not only bolsters the 2017 tax cuts but opens the way for consideration of ideas such as further cutting the corporate tax rate and exempting tips from federal income taxes, said Grover Norquist, an influential voice in Republican tax policy debates and president of the conservative group Americans for Tax Reform.

Trump enthusiastically promoted both the corporate-rate reduction and the break for tipped income during the presidential campaign and also promised myriad other tax breaks.

The first thing Republicans will have to negotiate is how large the tax-cut package will be and how much they’re willing to increase a federal deficit that reached $1.83 trillion in the fiscal year that ended Sept 30. Just extending the expiring tax cuts would drive up deficits by $4.6 trillion over 10 years, and all of Trump’s campaign plans would add as much as $7.75 trillion, according to estimates by the Committee for a Responsible Federal Budget, a nonpartisan fiscal watchdog group.

Stephen Moore, a senior fellow at the Heritage Foundation and informal Trump advisor, said the tax cuts will stimulate economic growth and Republicans can also cancel spending approved under President Joe Biden to help offset the cost of the cuts. Still, the bill is likely to have some level of deficit financing, he said.

That sets up a clash within the GOP between deficit hawks and lawmakers who don’t think revenue losses from tax cuts need to be offset, said Sage Eastman, a Republican strategist and former aide to the House Ways and Means Committee, which has jurisdiction over tax legislation.

Republican Senator Mike Crapo of Idaho, who is in line to chair the Senate Finance Committee, has said “pro-growth” tax policies don’t need to be paid for. The 2017 tax cuts did produce some positive economic effects, but they were far more modest than the Trump administration and some Republicans forecast, said Kyle Pomerleau, a senior fellow with the American Enterprise Institute.

“It will be important to watch to see if markets start to panic if enough deficit spending is being contemplated, or if they’ll decide to look through it,” said Martha Gimbel, executive director of The Budget Lab at Yale and a former White House economist under Biden.

Trump has vowed to impose a tariff of 10% to 20% on all imported goods plus 60% on Chinese products and promoted that as an offset for tax cuts. But lawmakers will have to decide whether to enact those tariffs in the tax bill so the revenue can be officially counted — a difficult vote for Republicans, especially those who want free trade. They could also just assume revenue would continue from presidentially imposed duties, even though Trump might later strike a trade deal that drops them.

“There’s always a way to make things work,” said Dave Camp, a senior policy advisor at PwC and a former Republican chairman of the House Ways and Means Committee.

The Peterson Institute for International Economics estimates the tariffs could raise only about $225 billion a year. Kimberly Clausing, a former Treasury Department official in the Biden administration and a UCLA professor of tax law, said the GOP will probably overestimate the revenue from tariffs and ignore the negative economic impact of the duties. 

Republicans have said they want to enact a tax bill within the first 100 days of Trump’s second term, though it’ll probably take longer to negotiate the details, Kumar said. 

The narrow GOP margin in the House gives small bands of Republican lawmakers leverage to demand specific tax breaks, and the Democratic strategy will be to focus on vulnerable Republican members in swing districts to push them to support or oppose individual provisions, said Scott Mulhauser, a Democratic strategist and veteran of legislative policy battles.

The Republican “trifecta” also sets up a lobbying free-for-all among business groups to persuade lawmakers and the White House to create new tax breaks to boost their industries. That intensifies the internecine struggle among Republicans over what to include in the package and how to contain the cost.

Skeptics said they doubt all of the tax cuts Trump proposed during the campaign — which grew so numerous that even some of his advisors are unclear about which proposals he’s most committed to — would be enacted because of the cost and difficulty of instituting the entire list.

Trump promised he would restore the full value of the state and local tax deduction, or SALT, a popular break in high-tax states including New York, New Jersey and California. Trump’s signature tax law capped the value of that deduction at $10,000, regardless of marital status.

While some changes to SALT such as raising the cap or doubling the deduction for married couples filing jointly are possible, eliminating the limit entirely isn’t likely because of the revenue loss: $1.2 trillion over 10 years, according to the Committee for a Responsible Federal Budget.