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Will Congress Close the Founders Stock 'Loophole' Too?

US Capitol Building with cash
US Capitol Building with cash

One of the points I’ve been making about “carried interest” is that it isn’t that different from other things that get taxed as capital gains.

It’s not some unique bizarre scandalous loophole in the tax code. It actually coheres quite well with the way we tax a lot of other returns on entrepreneurial activity.

When explaining this to people around New York City, I often find it useful to point to the ownership stakes in venture capital funded tech start-ups owned by founders. The labor of the founders is often what makes the value of these companies grow. But the tax code doesn’t treat these gains as ordinary income—it treats them as capital gains.

Founders stock, in that way, is just like the “carried interest” of hedge fund managers. Its value that is created by the work of its owner but gets treated like capital.

As it turns out, I’m not the only one who sees things this way. The guy who started the entire debate about “carried interest”—law professor Victor Fleischer—totally agrees with me about the similarities between founders stock and hedge fund managers carried interests.

But he comes to the opposite conclusion: He says we should raise taxes on founders stock, too.

Nicholas Kristof of the New York Times explains:

At a time when the richest 1 percent of Americans have a greater collective net worth than the entire bottom 90 percent, there are other ways we could raise money while also making tax policy more equitable. The White House is backing some of them in its negotiations with Congress, but others aren’t even in play.

One important proposal has to do with founder’s stock, the shares people own in companies they found. Professor Fleischer has written an interesting paper persuasively arguing that founder’s stock is hugely undertaxed. It, too, is essentially a return on labor, not capital, and shouldn’t benefit from the low capital gains rate.

Got that, start up folks? The tax man’s bell is tolling for you too.

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