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Silicon Valley is freaking out about this provision in the Senate tax bill regarding stock options

  • The Senate's tax reform proposal released last week would tax stock options when employees receive the right to them.
  • Venture capitalists and start-up founders say the proposal would severely limit the ability for U.S. companies, especially in tech, to compete.
  • "Generally it'll put a deep freeze on recruitment of the best talent into high-growth, innovative industries," said Leigh Drogen, founder and CEO of Estimize, which collects and publishes financial estimates for data such as earnings.
From left Amazon founder Jeff Bezos, Alphabet CEO Larry Page, and Facebook COO Sheryl Sandberg listen during a meeting with technology industry leaders at Trump Tower in New York, NY on Wednesday, Dec. 14, 2016.
Jabin Botsford | The Washington Post | Getty Images
From left Amazon founder Jeff Bezos, Alphabet CEO Larry Page, and Facebook COO Sheryl Sandberg listen during a meeting with technology industry leaders at Trump Tower in New York, NY on Wednesday, Dec. 14, 2016.

Start-ups are worried about one part of the Senate's tax reform proposal that would hurt their ability to compete: taxing stock options when they vest, instead of when they are exercised, as is currently done.

Companies, often Silicon Valley start-ups such as Twitter, typically compensate employees with the promise of being able to cash out on the company's stock in the future. Usually, the right to those shares is distributed over time, a process known as vesting. Stock options are currently taxed when they're exercised, or sold at a set price.

The Senate bill if it became law "would be the end of equity compensation in startups as we know it," Fred Wilson, managing partner at venture capital firm Union Square Ventures, said in a blog post Monday.

"If this provision becomes law, startup and growth tech companies will not be able to offer equity compensation to their employees," Wilson said. "We will see equity compensation replaced with cash compensation and the ability to share in the wealth creation at your employer will be taken away. This has profound implications for those who work in tech companies and equally profound implications for the competitiveness of the US tech sector."

The Senate's bill would tax employees on those shares even before their potential gain is realized. As a result, employees may owe taxes on something they only have the rights to and don't actually own.

"Generally it'll put a deep freeze on recruitment of the best talent into high-growth, innovative industries," said Leigh Drogen, founder and CEO of Estimize, a six-year-old company that collects and publishes financial estimates for data such as earnings. "There's no way you could hire the best talent to a start-up or high-growth company. It's just impossible."

Drogen said Estimize's roughly 20 employees collectively own about 15 percent of the company through stock options worth about $15 million in the next year or two. "That's an order of magnitude more than our payroll," Drogen said. The "risk they took to join us early on is dependent on that stock."

The Senate is set to begin discussing the proposal as early as Monday. A spokeswoman for the Senate Finance Committee did not immediately return a CNBC request for comment.

"It's really creating some heartburn in Silicon Valley," said Dan Clifton, head of policy research at Strategas. "There's some larger companies, not just venture companies, that are worried about this."

That said, the Senate's proposal on taxing stock options may not make it into the final tax law.

The House Republicans' tax reform bill would only tax stock options when they are liquid, rather when an employee exercises the options.

— CNBC's Patti Domm and Lora Kolodny contributed to this report.

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