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PDtax
PDtax, CPA firm owner
Category: Tax
Satisfied Customers: 1867
Experience:  32 years tax experience, including four years at a Big 4 firm.
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Sweat equity, I was given a contract to hire (which is probably

Customer Question

Sweat equity, I was given a contract to hire (which is probably really a IRS definition of an employee...but whatever) in 2010 to work for a start up for 2-4 months for 160 shares per month for a maximum of 480 shares of stock. They told me they "had a recent evaluation" (which they cannot come up with) at $150/share. They had 10K available shares. They started paying me as an employee in June 2011. They never issued the shares. my position was eliminated in June 2013 with one month severance with an offer of one month pay and it stated I had no other stock, options, compensation, etc due from the company. I hired an attorney for negotiate a better severance. They denied I had any shares until August 2013 when they (without agreement) issued 480 shares and issued a 1099MISC with nonemployee compensation back to 2010 and 2011 for 72K. This willbe a significant tax burden for me and I believe the shares are not worth $150 and there was no validation. I do not believe they qualify for constructive receipt as they denied I had any until this month. They will not settle the rest of the issues without me selling my shares back to them to remove myself as a stock holder. They are offering only 15K or so for the August 13th granting of 72K in shares. I can only take a loss of 3K a year. I have two questions: 1) is the constructive receipt in 2010 and 2011 valid and 2) How do I prove the shares are NOT worth (nor have been worth) $150 a share which I believe was only made for me in retaliation?
Submitted: 10 months ago.
Category: Tax
Expert:  PDtax replied 10 months ago.

PDtax :

Welcome to the site. I will be assisting today.

PDtax :

There are a few valuation issues here, as well as a negotiated settlement for your compensation. Since you appear to be in negotiations to settle your issues with the company, I would start by saying that just because the 1099 misc was issued, doesn't mean that is the final assignment of income to you.

PDtax :

I don't know what the rest of your dispute is with the company, so the potential of a discounted buyout, likely not even enough to pay the tax, interest and penalties, leads me to think there is more to this. But, I will focus on your question.

PDtax :

Before I forget, your first sentence likely points out a significant negotiating tool for you. As an employee, the company would be liable for all the income taxes, social security taxes, interest and penalties for misclassifying your stock compensation. I suspect IRS would indeed characterize you as an employee. The mere suggestion that IRS will reclass your compensation might be a significant negotiating tool. Just a thought to file away and suggest to your attorney. Your employer would also be liable for workmen's comp and any other employee fringes. I know that's not your question, but keep that in mind. Now, to constructive receipt.

PDtax :

Constructive receipt has become a doctrine that can be argued, often for receipt of income in an earlier year. IRS would not make this argument, your former employer would. Since it took you two years to negotiate the arrangement, your employer would have the burden to prove that 2010 and 2011 were the years you received the income, which they are unlikely to prevail on. If the 1099-MISC filings are not revised, which I would not allow in negotiations, my tax returns would be filed arguing employee status, and the fact the income was not received in 2010 and 2011. i

PDtax :

IRC 451 (a) covers constructive receipt, and supports your position that the stock was not remitted and yours without substantial limitations until August 2013.

PDtax :

Now, to the second point. You are assuming that your former employer can at once determine a value for your compensation without documentation, then negotiate a buyback at significantly less. I believe they can, but you are missing several key elements.

PDtax :

The value attached to the shares must be supported by valuation or other such support for your employer to claim tax deduction for the amounts. Since you have asked nicely, and been rebuked, you may want to ask who performed the valuation and ask that third party for a copy. Since that request will be denied, you will likely haver to litigate, which your former employer won't want (see the employee issue earlier - since you were an employee, they will have to pay all the taxes and likely the cost of litigation for $72,000 net pay). If they lose, your pay would likely be grossed up to $125,000 or so to cover the income taxes, payroll taxes and such that should have been withheld as an employee. The employer will be liable for all of it, and interest and penalties. This is separate from their offer of buyback.

PDtax :

The offer of buyback is interesting, but since you now have shares, you receive some rights in ownership, such as the right to see company tax returns, that minority shareholders have. A review of these rights with your attorney is appropriate.

PDtax :

Now, on to the buyback of the shares. They can offer you anything they want for the shares, and such an offer would normally be separate from the compensation issue. The problem is they just valued them at $72,000 only weeks before. This would allow you to file a dispute on your tax return regarding value. IRS would then get involved.

PDtax :

I would be ready to litigate all of it. You are not negotiating in good faith, and you can have persuasive arguments for both constructive receipt (you should prevail), the valuation (your attorney will have the right of discovery, which will force the valuation to be delivered), a judge to hear the equity of the value assigned (their offer of much less could be used as a measure of the shares worth) and the biggest issue you have in your favor, that of employee classification, which you may prevail on since you have a contract to hire and were retained as a traditional employee in June 2011).

PDtax :

Thanks for asking at Just Answer. I'm PDtax. Ask any follow up you like, or leave positive feedback if I have answered your questions.

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