S-Corp / Owning Shares In Another Company
Submitted by Anonymous on Mon, 2008-08-11 18:19.
Company A (an S-Corp) as part of a service contract receives an equity position in Company B. The position cliff vests X years into the future.
How should Company A proceed when (A) the vesting occurs and (B) when it sells its stock?
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Stock for Services is Income
Without seeing the agreement it's hard to say for sure because there are lot of nuances that could affect my answer. :)
But in general, stock received in exchange for services is income. In fact if you had received a car or a Picaso, it too is considered income. Company A will report the value of the shares as income on its 1120S as if it was cash as it vests.
Company A doesn't recognize the income until the shares vest and it has full ownership. At that time, recognize the income equal to the fair market value (FMV) of the shares on the vest date less any cash paid for the shares (if any).
For example, let's say Company A was granted 1000 that vest over 4 years. After the first year 25% of the shares vest and the FMV of the shares is $1/share. Company A has to recognize $250 of income & now owns $250 worth of stock in Company B. After 2 years, the stock's FMV is $10/share. Company A has to recognized $2500 of income. And so on.
The amount recognized as income at vesting is Company A's basis in the stock. So if after year 2 it sells the 250 shares that vested at year 1 for $2500 it has $2250 of capital gains (250 shares @ $10/share - $250 basis). This capital gain will flow to the shareholders' individual tax return.
It's possible that the shares are eligible for Section 83(b) treatment which allows you to recognize all the income in the year of grant. This could be advantageous if you think the value of Company B will dramatically increase.
There is much, much more on restricted stock and stock grants at Fairmark.com and MyStockOptions.com. The 83(b) election must be made to the IRS in writing within 30 days of transfer so I would find out about that as soon as possible.
Hope this helps!
L:)
Great input....thanks,
Great input....thanks, Linda. The agreement is still in the formulation stage and the S Corp is looking for pitfalls and opportunities.
So what happens upon vesting with regards to the ownership of Company B's stock? In this example, there is only one employee/owner in Company A (again, an S Corp). Is there anything that needs to be done (or should be done) to pass ownership of the stock "through" the S Corp to the individual (in this example) at that time or is that all in effect handled through the annual reporting at both the corporate and individual level?
Filing an 83(b) is a temptation in that the value of Company B's stock has followed a steady growth pattern and has a solid outlook (a doubling of value in this period of time seems quite possible). It would be nice - at least in that scenario - to pay just the 15% rate on the future gap between today's value and the ultimate sale price instead of 35% (or whatever the individual's rate ended up being...likely the highest rate)! But wouldn't this serve to (more so) lock the S Corp into the agreement as those "early" tax payments would not be recoverable if the agreement was terminated before the vesting occurred?
Another issue is that the stock is not publicly traded and it may be difficult for Company A to sell some/all of the Company B stock once it vests to help cover the necessary tax payments. Even at expected growth rates, this will mean a sizable tax bill on vesting day. Any ideas on ways to help minimize this shock? Or does the S Corp (or rather its owner/employee) just need to get a big piggy bank and start saving?