As a business owner, what do you do when you want to reward a key employee for his or her hard work? A cash bonus, maybe. But what if cash is tight, or you want to do something that may have more meaning or encourage longevity with the company. You, as the business owner, can give or sell at a discount to the employee some portion of your personal stock in the company, enticing the individual with “skin in the game.” Setting aside any shareholder agreement restrictions between you and other shareholders which may prohibit or restrict such transfers and which should be considered and cleared, this sounds like a perfectly straightforward transaction. There are, however, tax matters to consider.
If you, as a stockholder, give stock to an employee in consideration for services performed by the employee for the company, you are deemed under IRS regulations to have made a capital contribution to your company that is then transferred to the recipient, causing the recipient of the stock to recognize compensation equal to the fair market value of the stock. Your company receives a corresponding compensation deduction. There is no gain or loss to you as the granting shareholder because the transfer is deemed a capital contribution by you, and your basis in the “deemed contributed” shares is transferred to your remaining shares.
Alternatively, what if you sell some portion of your stock at a discount to a company employee? Although commentators disagree because language in the applicable IRS regulations is not entirely clear, it appears that the transferred shares are still deemed contributed to the company by the transferring shareholder, whose basis in the “deemed contributed” shares is transferred to the transferring shareholder’s remaining shares. The recipient employee recognizes compensation equal to the fair market value of the stock, reduced by the purchase price, and the company receives a corresponding compensation deduction, just as in the situation where the recipient paid nothing for the stock. The regulations treat the reduced purchase price paid by the employee as a deemed payment to the company, followed by a distribution of that amount to the transferring shareholder as a redemption transaction.
In short, shareholder transfers of stock to employees for reduced or no purchase price are certainly possible, but careful analysis must be made under the facts at hand to evaluate potential compensation issues. Kreis Enderle attorneys can provide valuable assistance to you ahead of such transfers to avoid surprises down the road.
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