Discussion:Sale of stock to employee (from shareholder or Co.)

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Discussion Forum Index --> Advanced Tax Questions --> Sale of stock to employee (from shareholder or Co.)


Discussion Forum Index --> Tax Questions --> Sale of stock to employee (from shareholder or Co.)

Johnhuddleston (talk|edits) said:

11 December 2007

My client owns 100% of an S-Corporation. He wants to sell a 10% share to his employee. As I see it, there is no tax if the Corporation sells the shares to the employee (IRC 1032), but client would pay capital gains if he sells the shares instead. So the Corporation should sell the shares, right?

John Huddleston

JR1 (talk|edits) said:

December 11, 2007
I agree. Similar situation with one of my clients. We'll comp it as a bonus at year end so the corp gets the deduction, and the corp issues the shares so no cap gain to the s/h. I can't think of a downside. And it's 1244 stock to boot that way, too.

Jdugancpa (talk|edits) said:

11 December 2007
John, this may be stating the obvious, but sometimes it is overlooked. If corp has 100 shares outstanding, the sole shareholder must sell 10 shares to the EE in order to effect a 10% sale. But if the EE purchases the shares from the corp, 10/110 = 9.09%. Therefore, to sell 10% ownership to the EE, corp must sell (100/.9)-100=11.11 shares. But as to your original question, I would concur.


JoelUT (talk|edits) said:

1 December 2012

Let's see if I can resurrect a 5-year-old thread.

JR1 said that it's 1244 stock to boot. I understand that stocks given to employees as compensation for service disallows 1244 loss treatment. Is this still true if the employee gets a bonus (and the corp gets the deduction) and the employee uses the same amount to purchase stock?

Podolin (talk|edits) said:

1 December 2012
Discussion:Corporation owners want to sell stock to key employees.

JoelUT (talk|edits) said:

1 December 2012
Thank you Podolin for pointing me to the thread.

While it didn't specify 1244 issue directly, I would imagine you were trying to imply that there are two different ways to look at this:

(Gfisher's post) "(1) The key employees are bonused the negotiated/agreed-upon stock price;

(2) The key employees pay for the stock out of post-tax dollars (i.e., their own pockets) by having payroll withholdings on an agreed-upon schedule."

Did you mean to tell me that if the underlying reason the employer gives an employee a bonus is so that they can purchase the stock would disqualify 1244 treatment because this is an compensation for service?

On the other hand, if the employee purchases some new stock from the corporation out of his own pocket, then this transaction is a qualified 1244 stock purchase?

Podolin (talk|edits) said:

1 December 2012
I don't see any specific limitation that would prevent them from using after-tax dollars to buy 1244 stock, assuming all other tests are met. However, I can see an argument that the step-transaction doctrine could apply, such that, when collapsed, the result is the same as if they had issued the stock as compensation. Example - here is $10,000 cash. Pay your 20% taxes (hypothetical) and invest $8,000 in stock. Or, here is $8,000 in stock, and we will pay your taxes (gross-up calculation required). I do not know if this has been the subject of a case or ruling, but it should be easy to find out.

Podolin (talk|edits) said:

2 December 2012
In fact, thinking a bit more about this, I think there could even be a problem qualifying the stock as 1244 stock without associating it with the bonus. Let's say the employee has the cash and buys the stock, even at full FMV. Usually, the stock will be restricted, implying a tie-in to compensation. Even if not, there is usually no reason to sell stock to an employee beyond compensation. All the reg. says is Stock issued for services rendered or to be rendered to, or for the benefit of, the issuing corporation does not qualify as section 1244 stock. Reg. 1.1244(c)-1. If the employee pays for the stock, he argues it was not for services rendered. IRS says it is, because there was no other reason to sell him the stock. Might win, might lose. Even worse odds if tied to a bonus as you suggest above.

JoelUT (talk|edits) said:

6 December 2012
Podolin,

Thank you very much!

That had pretty much shot down 1244 issued stock that my client gave to the employee.

Oh well. Better to know now than at tax time.

Ckenefick (talk|edits) said:

7 December 2012
Even if not, there is usually no reason to sell stock to an employee beyond compensation. All the reg. says is Stock issued for services rendered or to be rendered to, or for the benefit of, the issuing corporation does not qualify as section 1244 stock. Reg. 1.1244(c)-1. If the employee pays for the stock, he argues it was not for services rendered. IRS says it is, because there was no other reason to sell him the stock. Might win, might lose. Even worse odds if tied to a bonus as you suggest above.

Ck says "you win." Clearly, if guy pays FMV for stock, the stock hasn't been issued for services rendered. It has been issued for cash. Moreover, guy could take the cash and go spend it on tax publications, tax planning services, etc. The guy is not bound to buy the stock with the cash he got.

Podolin (talk|edits) said:

7 December 2012
Chris, you'd say then that restricted stock, FMV $10/share, sold to employees only at that price, but restricted in typical fashion tied to employment for a certain amount of time, can be 1244 stock. Employee makes 30-day election, pays FMV, so no income. Company tanks. Ordinary loss, right? Or do you only reach that conclusion where there is no restriction (which, I believe, would be rare)?

JoelUT (talk|edits) said:

7 December 2012
In my case, there are no restricted stocks, which must be rare as Podolin indicated. The employer decided to be generous by giving his key employee, who has been with him for many years, 19% of the company as a reward. What led to this stock issue was that the owner had sold his automotive business to a third-party, but right before the sale of business, decided to give his key employee 19% of the company. That new shareholder will get to receive 19% from the sale of business as a reward.

The employee IS going to have a wage equal to the FMV of the company (the valuation of the business sale is already accounted for in the FMV). This employee will immediately invest the cash back into the company to become a party of the sales proceed and liquidation. In fact, he'd be dumb not to, he KNOWS money is coming to him even though it's an installment sale over 7 years.

With the regs, I just don't see how the employee could argue that he was investing into the company instead of getting the stock as a compensation for years of loyalty, even though there was no obligation on the owner's part.

Both the employer and employee are retiring.

Ckenefick (talk|edits) said:

7 December 2012
Joel, sounds like you're saying the corporation (i.e. employer) issued stock directly to the employee as compensation, so you have a problem. An actual cash bonus would have worked better.

Or do you only reach that conclusion where there is no restriction (which, I believe, would be rare)?

Not rare, see what Joel just wrote. No restrictions needed in Joel's case...no need to tie down recipient employee. He's retiring.

Podolin (talk|edits) said:

7 December 2012
I'll just add "rare in my experience".

Podolin (talk|edits) said:

7 December 2012
With the facts as amplified, 1244 is not even relevant.

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