Employment agreement converts to equity position, what is my tax liability?

One approach I've seen to reduce the sting is for you to pay the $75,000 with a note payable over a period of time. They could then forgive each annual payment as it comes due, spreading out your recognized income over a period of years.

They could also give you a bonus each year that would be enough to pay the additional tax.

Your current contract has little or no market value. First of all they can fire you at any time. Also, you can't sell the job to someone else who wants to work for the company, because they're not required to allow the buyer to work for them. But an equity interest can't normally be taken from you without reasonable compensation.

They could incorporate the company, and then everyone can get better retirement accounts. Or you could create your own business and have that business contract with your current employer for your services. Your current employer would pay a simple fee, you would do your own taxes and withholding, and be self-employed without having to buy in to the company.

Sounds like your CPA doesn't have a creative or proactive bone in his body. Check with a business/tax lawyer about the best way to resolve your issues.

Stu

Before, you just had an employment agreement and your income was the money paid.

Now, you would have ownership of part of the company. That has value. Think of it as them paying you $75,000 (income) and then you turning around and buying into the company for $75,000 (investment-not expense).

You want to be certain of the $75,000 valuation figure. How was it calculated? There are many approaches to valuing a business. It is to your advantage for this value to be as low as possible. It would reduce your current income tax liability although it would increase any capital gain in the future.

Questions- What type of entity is the company (partnership, corporation, S-corporation)? How will this make you self-employed and increase your retirement investments? It could actually reduce the retirement amounts depending on the circumstances. Also, ownership could impact your fringe benefits taxation depending on the entity type, company size, structure, etc. I suggest you consult your own local CPA so you understand the full impact of this especially since you are already getting 10% of the company's profit.

well said, Stu. (Hmm, my spell checker wanted to change that to Stud).

As long as we are suggesting investigation of other matters, what is the form of the business? Is it a partnership? A 10% partner is 100% liable, isn't it? If it is an LLC or corporation, is it being run properly, as far as "piercing the corporate veil" is concerned?

How is your CPA arriving at the $75k figure? Is the business worth $750k? How did he figure that? Did he consider that a 10% ownership share of a business worth $750k is worth less than 10% of 750K? (minority ownership).

Is the business likely to grow over time, so your 75k investment grow? Or will it shrink and go away (I know some people involved in such businesses), so your $75k investment will decline?

what is your salary? You are giving that up? No salary, but a 10% owner entitled to 10% of the net, vs. your current situation, i.e. a salary PLUS

10% of the net? How much does the business need to grow for you to break even on this offer?

It's difficult to give an informed opinion here with so many unknowns. Is your salary plus 10% of IBT greater than 75K? Will your income as a 10% owner be greater than your current income? Is this an LLC, a Partnership, an S-Corp, or a C-Corp?

Let's start with the fact that you never paid taxes on the value of your employment agreement. Therefore, you have has a zero basis in the contract and the difference is the 75K.

Someone else suggested you pay then $75K for the 10% interest on a

10 year note with the understanding that 10% will be forgiven each year. This is a common practice.

How did you become self-employed? Unless this is an LLC or a Partnership, you are still an employee.

People who are self-employment pay an additional 7.65% in employment taxes. What will happen to your current employee benefits as in out of whose pocket will they be paid?

You need a CPA, an EA, or a Tax Attorney to run the numbers for you.

Dick

Thanks for all the great responses folks. I will answer questions here for efficiency sake. It is an s corp. My salary will continue to grow provided the business continues it past success. in '08 it was 78K and I was entitled to 48K in bonus...I took 25k and deferred 23K(left in company). I would continue to take my salary as W2 income...I don't think that should or would change?? We currently have a SEP with 3% company match but contribution limits are approx $10,300(I dont have the exact amount info here but it is close)...my problem is that my income is eliminating what retirement programs I am eligible for. As I understand, as an owner I can contribute up to 51K per year tax deferred.(I have some catching up to do in this area... and will be 50 next May.) I do need advise and do not think I am getting any creative advise from our cpa or the cpa firms attorney. In fact they seem more interested in "protecting" the existing owners interest then in helping us solve this buy in tax liability issue. You folks have clearly shown me that i need outside advise on this. Merry Christmas too. Ed