Timing on Income

[S T]

I have a CEO of a company that is selling/merging - CEO- Employee will be compensated through some stock Options, that all will be grossed up through the Payroll - No Issue on that as all should be represented on the 2012 W-2 Form and appropriate Taxes withheld - - they want to close all by 12/31/212.

Question now is that the Company selling and new company merging has a "caveat" to offset a "holdback" until 2014 on approximately $ 750K of this amount (included on the W-2 form 2012) So T/P has "phantom Income" for 2012 and pays taxes on that amount of the holdback

Can the "old Company do this" legally - as it will be processed through payroll and affect 2012 Employee Wages on W-2 Form - NOT 2014 (won't be processed on a 2014 W-2 form)

How does this affect the T/P - other than reporting n 2012 Income???

I am thinking if processed through payroll in 2012 all is processed through 2012 payroll gross up , and then what ever amount released in 2014 - has no tax consequence in 2014 - the $ 750K released in 2014 would have been already taxed.

I can imagine some "pitfalls" on the Employee Side - and I believe this is mostly one sided on the Company/Employer Side to close their books in 2012

What pitfalls to look for on the Employee Side ------Any thoughts??? I probably did not state this very well on the question- but I am guessing someone will let me know for more info.

Thanks

Sandy

[Snaggletooth]

Wow!

Sandy, how do you find these people?

As usual, if it's very complicated I will have a problem tuning in. And I don't understand how this can be if his rights to the stock are not complete.

There are usually two phenomena involved. First, the employee EXERCISES the stock option and at that point incurs the compensation income on his W-2. Then, commonly, the employee sells the stocks that he has just acquired back to the company. The 2nd phenomena usually takes only a matter of a day or two, and usually the stock gains or loses a little bit so there is capital gains of a small amount of money.

Keep in mind that the 2nd step is NOT mandatory. So long as the stock is common stock, the employee does not have to sell it. He can hold on to it. This is where I believe this "holdback" may be occurring.

Let's build a possible scenario for your client. He will exercise his stock options and incur on his 2012 W-2 all the compensation that will be recorded. No more compensation. But now let's say that he is not permitted to sell the stock because 1)it has been converted from stock of company A to the stock of company B, and 2)the buyout arrangement forbids sale of stock back to the treasury during a holdback period.

In 2014 your client can then redeem the stock, or hold it. If he disposes of it, there will be capital gain or loss either way, and all reporting will be complete at that time. Keep in mind that usually such restrictions on stock always result in a severely depressed stock value, and there is no guarantee that his stock will be worth another $750,000 two years' hence.

These "holdbacks" are created by the merging companies because the absorbing company wants a little cushion to make sure they are getting purported value of the old company Receivables or Inventory. If these are overstated, the new company usually discovers this within a year. The new company often wants a remedy in case they are buying bad stuff.

If you've followed the income stream, you've probably picked up on the fact that if the seller is selling purported value, your client has just converted $750,000 from compensation to capital gains. Hopefully in 2014, capital gains will still be at favored rates. IRS probably frowns on this but I don't know what they can do about it.

Sandy, does this make sense? What do others think?

[S T]

Thanks Snags,

Just the way 2012 has been going - Long Time Client so not that a T/P found me! I don't seek out these issues, they has just been arriving! Can't wait for 2013 to arrive! I can't ever remember when I have been faced with so many challenges in on year!

Your thoughts do make sense, for the question in both the t/p mind as well as my own for 2012 and 2014

We have a few days to figure this out - but not many like maybe 30 days - so as a long time t/p of mine - at least he is asking questions in front before the deal is done, and after questions later!

We will see how others weigh in as well - but this is really good information you posted.

Thanks for always being there or here on the Board!

Sandy

[DaveO]

I think Snags in on the right track. We are seeing a similar situation with Facebook as the various holding periods expire and the insiders are allowed to sell their shares.

[Nashville]

What To Do?

Snag's interpretation might be correct, but even if so, this is only one scenario. The big question is "What should be done as a preparer?"

The compensation resulting from the stock option exercise will be appearing on the 2012 W-2, according to what the client has said. Ask to see documentation coming from the exercise and be sure to make note of the number and value of the shares involved as to both market value and strike price. The market value becomes the new basis, and if not publicly traded, will be established by an appraisal for the corporation.

If the shares acquired are from the "old" company, they might need to be converted (both quantity and price) to the "new" company as the "old" company will not be around. His basis should not change by virtue of the conversion, unless reduced if he is paid some small boot (which commonly happens, especially with partial shares).

When your client engages in future transactions with these stocks, whether it be 2012, 2013, or 2014, you can handle the event in accordance with typical handling of stock transactions.

[Gary2]

I suggest a more precise statement of what's going on, being specific as to company A, company B, exercise date, conversion date (if any), the nature of the restrictions, the nature of the hold back, etc.

I'm used to seeing "hold back" to refer to something different from "restrictions on sale." In a common situation, employee E will exercise options on 100 shares, which in some circumstances triggers a taxable compensation event (line 7 income), for which company C must submit withholding tax. To do this, holds back some of the shares, and thus may only deliver 75 shares to E. The remaining 25 shares, which also belong to E are sold by C on E's behalf. (It doesn't matter whether they sell it to their own treasury or to a third party.) That sale triggers a second taxable event (Sch. D), and the proceeds are transferred to the government as withholding taxes, again on E's behalf, and should be added into E's W-2. Any gain or loss from the sale is typically tiny, and often 0 (and I'll ignore the discussion about whether it must be reported).

Since the terms don't have a formal definition, it's entirely possible that the new company is saying "we're holding back this stock, even though it's in your name, so that we can enforce the restrictions on the sale." Often, there's no tax due if the restrictions are significant, which is what's confusing me about the current description. Perhaps they mean "hold back" as I described above, or perhaps they mean "hold back" in the latter sense, and they're not imputing income from the amount held back, or perhaps the circumstances are such that income must be reported even though the employer is keeping custody of the stock. Hence the need for a more precise description of the scenario.

[S T]

Employee through Compensation will receive $ - All stock is being sold (cash transaction) , and the indemnity holdback will be cash in an escrow account. No shares of stock to be retained or new company stock to be issued.

Question is to report entire sale in 2012, then when indemnity holdback is released in 2014- no gain reported (as all reported in 2012) - however, if holdback released is less in 2014 there would be a loss?

5.750.000 Million Cash transaction 2012
750.000 hold back - cash released in 2014 ** could be less if claims

Net cash in 2012 - 5 Mil

Thanks

Sandy

[JoshinNC]

I had this situation last year

All stock is being sold (cash transaction) , and the indemnity holdback will be cash in an escrow account. No shares of stock to be retained or new company stock to be issued.

Question is to report entire sale in 2012, then when indemnity holdback is released in 2014- no gain reported (as all reported in 2012) - however, if holdback released is less in 2014 there would be a loss?

5.750.000 Million Cash transaction 2012
750.000 hold back - cash released in 2014 ** could be less if claims

Net cash in 2012 - 5 Mil

Thanks

Sandy

And we reported gain on entire sale price in 2011 with holdback paid out in 2012. The sale was completed and consummated in 2011, so we reported all gain/(loss) in 2011. It is electing out of installment sale treatment, otherwise installment rules would apply.

[Golden Rocket]

Installment Sale?

It is electing out of installment sale treatment, otherwise installment rules would apply.

I agree in theory that if the holdback is simply in cash [this means all stock transactions are over with in 2012], and the remainder is paid in 2014, then installment method is theoretically correct.

However, unless I'm missing something, the logistics are horrible. Client will receive W-2 for the income resulting from exercise of stock options, and an amount withheld will be translated into shares unavailable for "sale." But all these stock transactions occur in 2012, and the only transaction not consummated will be an additional cash payment in 2014.

However, what amount is shown on the W-2?
a) The full amount, including the holdback. That means client has to report all the income as compensation in 2012, including income he never received.
b) The amount minus the holdback. That allows reporting under the installment theory, but the issuing company will not be around in 2014 to issue a W-2. Does client then report holdback on line 7 with no matching document?
c) Most installment sales flow to Schedule D, or form 4797. Not aware of any flow from 6252 to line 7.
d) Social security and medicare (since this is compensation) reported in 2014? All of this has been withheld (I think) in 2012 but govt will be looking for more.

Any answers?

[S T]

.

However, what amount is shown on the W-2?
a) The full amount, including the holdback. That means client has to report all the income as compensation in 2012, including income he never received.
b) The amount minus the holdback. That allows reporting under the installment theory, but the issuing company will not be around in 2014 to issue a W-2. Does client then report holdback on line 7 with no matching document?
c) Most installment sales flow to Schedule D, or form 4797. Not aware of any flow from 6252 to line 7.
d) Social security and medicare (since this is compensation) reported in 2014? All of this has been withheld (I think) in 2012 but govt will be looking for more.

Any answers?

a) yes - full amount to be reported on W-2 for 2012 - as compensation,
not sure if there will be a 1099B issued for the stock exercised

d) should be no documents reported in 2014 - so not sure what govt would be looking for?

Sandy

[Gary2]

Employee through Compensation will receive $ - All stock is being sold (cash transaction) , and the indemnity holdback will be cash in an escrow account. No shares of stock to be retained or new company stock to be issued.

How is the indemnity related to the stock sale? I would think there's a difference between an ordinary installment sale, in which the purchase funds aren't provided to the seller at all until a future year (and may not even exist at the time of the sale) and a more complicated deal in which the funds are technically transferred to the seller, but held by an escrow agent as security against some future event.

[BHoffman]

Constructive Receipt

I think the t/p needs to have constructive receipt before it can be reported on a W2.