My employer, a small startup, is $100K behind in paying my salary. The company has offered me 200K shares of company stock in lieu of back salary, which I've agreed in principle to accept. From a tax perspective, what's the best way to structure the deal? Stock options? A stock grant? Something else? If if would make a significant difference, the deal could be spread across a couple years. Thanks!

AtlantaTaxExpert

Whatever the methodology used, the stock is compensation and will be subject to Social Security and Medicare taxes.

You need to contact a local tax pro, either an experienced tax preparer, an enrolled agent or a CPA. There are so many variables (other income sources, spouse/children, total salary, etc.) that I cannot even begin to give advice.

metagami

Here's the proposal that's on the table. The company lends me $100K, which I use to immediately purchase the stock. The company pays my back salary in installments over three years, withholding required payroll taxes. The balance of each paycheck is applied to my $100K loan from the company. The amount of back pay is adjusted so that I receive exactly $100K after taxes, thus paying off the loan. Except for the money that goes to the taxing authorities, does any cash actually need to change hands, or can it all be done on paper? The problem is, the company doesn't actually have $100K right now. It does have $20K, so if we actually had to transfer funds between accounts, we could simply repeat the transaction 5 times.

AtlantaTaxExpert

Even though money has not changed hands, you have constructive receipt of the compensation in the form of the stock.

I see nothing wrong with the transaction, though I stand by my previous recommendation: Get competent local tax advice. Further, I would get the agreement in writing and have an attorney review the document before agreeing to it.

taxsearcher

Company pays you the stock (you report the stock's value as income) and the company deducts the same amount as compensation.

IntlTax

If the company "lends" you money with no expectation of repayment of the "loan", then the transaction will probably not be characterized as a loan. Instead, when you receive the cash/stock in year 1, you will probably be taxed on the full amount.

AtlantaTaxExpert

IntlTax:

There IS expectation of repayment. He says "The balance of each paycheck is applied to my $100K loan from the company".

IntlTax

I disagree. This arrangement is being made because the employer is "$100K behind in paying my salary". If the arrangement were related to future services, then I think it might work.

Here, the net result is that an employer owes an employee for past services. The employer is going to provide stock in lieu of cash. The loan and later recording of salary is window dressing to try to defer the recognition of income (and to defer the deduction).

The U.S. tax law looks to the substance of the transaction. The substance of this transaction is that stock is being received in lieu of cash. No cash transfers are necessary with regard to the loan/purchase and salary/repayment. If any cash transfers were to occur related to these transactions, they would be circular (but for taxes paid). Circular flows of cash are often disregarded if the substance of the transaction is different than the form.

If this were to work, then I could "loan" cash to my employees this year (or for several years) and pay them a salary next year (or later) which would be used to repay the loan. The employees could defer the recognition of income for one or more years. Nice deferral strategy, but it doesn't work.

AtlantaTaxExpert

TaxSearcher, what do you think?

taxsearcher

ATG,

I agree with IntlTax's point that this won't hold up. What the parties call it is irrelevant; the courts will look to see the true nature. Here, the parties have called it a loan. What matters is what it really represents.

I believe that the courts have also found that loans made where the employee will forgo future salary are not bona fide loans.

Reality is that he has received stock as compensation.