Have a Tax Question? Ask a Tax Expert
Hi and welcome to our site!If you will be working as an independent contractor - there would not be any wages - but as a contractor - you will receive a compensation for services which would be your self-employment income. So you need to be clear 0- if you will be an employee with wages reported on W2 form OR you will be independent contractor with compensation reported on 1099MISC form.That distinction is very important because there would be different tax treatment and different reporting.
As you will be receiving an equity in the business - I assume that the business is a corporation - and you will receive shares of that corporation as a compensation for services - the fair value of these shares must be included into your income. That value will be reported correspondingly on W2 form as wages if you are an employee or on 1099MISC if you are an independent contractor.There might be not a simple to determine the FMV of shares because they are not trading on the open market - but that must be done. That value will be your basis in shares - so when you will sell shares in future that value will be used to calculate your gain or loss at that time.
To give a bit of background, I am working from home for a foreign company with all their business being conducted abroad. The tax situation got really complicated if I went in as an employee, so it's being handled as an independent contractor. However, they will be paying me an annual salary.
While I will be "paying in" for these shares, I do not actually own them for five years. However, I do receive the benefits of them (like dividend payouts and stuff in the future). Is there a better way to structure the agreement to benefit my tax situation?
Thanks for clarification. Yes - you will be an independent contractor - but using the term"salary" is where the confusion started. In case you are an independent contractor - you will receive a compensation for services - not salary.
For federal tax purposes - you will report all business income and expenses - on the schedule C -http://www.irs.gov/pub/irs-pdf/f1040sc.pdfThe net income (after deductions)will be reported on the form 1040 line 12 - http://www.irs.gov/pub/irs-pdf/f1040.pdfIf the business has net income over $400, it may be required to file Schedule SE, Self-Employment Tax and net income is likely self-employment income and 15.3% self-employment tax would be required.Self-employment taxes from schedule SE will go to the form 1040 line 56 - http://www.irs.gov/pub/irs-pdf/f1040.pdf Also - you will deduct half of self-employment taxes on the line 27. Generally - that all you needs for income tax purposes . Please review all possible deductions - that might help to reduce income tax liability.
But for the equity, is that income now, or is it something in the future since actual ownership does not vest for five years? And does that make sense, or is it more beneficial to restructure it?
Basically, right now I have some options on how to structure the equity payouts, and I want to make sure that I keep it tax adventageous.
Yes - if you receive anything in value as a compensation for your services - that is your income. If the equity you receive is NOT vested - means - you have not constructively received it.
As it's currently set up, I am earning 'x/2' in equity per year, but that equity is not mine until it is paid off in five years. So is that 'x/2' counted as income today, or in five years when the equity actually becomes mine?
And from a tax perspective, which is better?
According to the IRS income is recognized when it is constructively received - means it is available for you.When you are given options which may not be exercised - that means - income is promised but NOT constructively received - and as such is not included into your income.
There is no "better"... all depends on circumstances and not all are under our control.If you receive shares now - and their value is relatively small - you will recognize small income but now.If you expect the value of shares will increase - there will be large taxable income but in five years...
Presumably the stock will increase in value, so that might lead to an untenable situation in five years if I get the stock, but cannot afford to pay the taxes on this "income."
So would it make sense to try to keep the unvested stock as current income through an 83b election?
Of course, if I do that, then I essentially pay taxes on 'x' even though I only get paid 'x/2', so my tax burden for the next five years will be double what it would normally be if I just received money, right?
That is also possible... So as we already mentioned - if share's value is relatively small today - it might be better to have them vested today and include in your income.Or if they are not vested - you may use section 83b election - but that would be more complex tax area.