(New throughout, adds comments from trade groups and Menlo Ventures)
SAN FRANCISCO, Nov 15 (Reuters) - Venture capitalists and startup executives, who had mounted a campaign against a proposal to change how the federal government taxes stock options, expressed relief on Wednesday after the U.S. Senate dropped the measure from its tax overhaul plan. The Senate tax bill had proposed taxing employee stock options, a crucial part of compensation at technology startups, as they vest. Options generally vest over a four-year period.
The result would have been annual tax bills for startup employees that soared into the tens of thousands of dollars, warned startup founders and employees. Startup options give employees the right to purchase shares in the future and are illiquid, meaning employees cannot spend or save their options.
The Senate removed that provision late Tuesday night following heavy lobbying from the National Venture Capital Association, the industry trade group, and an outpouring of opposition from Silicon Valley venture capitalists and entrepreneurs. They predicted the demise of the startup industry should the tax become law.
"The entrepreneurial ecosystem can breathe a sigh of relief," said Bobby Franklin, president and chief executive of the trade association.
More than 600 startups, investors and executives from companies such as Uber, Airbnb and Stripe signed a letter Tuesday to Senate Finance Committee Chairman Orrin Hatch, urging him to remove the provision.
"This shift would have profound negative consequences for technology startups by, among other things, undermining their ability to compete with large incumbents for employees," they wrote in the letter, organized by technology advocacy group Engine.
A spokesman for Hatch did not respond to a request for comment.
The current tax code taxes employees only when they exercise their options. The Senate proposal would have required employees to pay regular income tax on the value gain of stock options even before cashing them in.
The National Venture Capital Association (NVCA) was also successful in getting a similar proposal removed from the original House tax reform bill.
"We don't anticipate it coming back up again," said Ben Veghte, spokesman for the NVCA.
In the new version of the Senate bill, the finance committee also added language that would enable startup employees to defer for five years their stock options tax bill if they reach the deadline to exercise them but the company is still private and shares do not trade on the public markets.
Venky Ganesan, managing director of Menlo Ventures, called the changes "consistent with economic growth and job creation." (Reporting by Heather Somerville; editing by Marguerita Choy and David Gregorio)