If you convey a few lawful precautions at the outset, you and your employees can sidestep some painful tax consequences

By Tom Taulli

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Working with outside investors to finance an early-stage company by issuing stock have power to be stressful, time-consuming, and complicate. For the most charge, founders will focus without interruption just a few key areas such as valuation and liquidation preferences. Most will overlook tax-planning, placing a big chunk of potential earnings for themselves and their employees at risk. To avoid this, founders should seek the assistance of a tax expert, of the like kind as a CPA or a tax deputy who understands the nuances of early-stage companies. To get a sentiment of two common tribute pitfalls and ways to keep aloof from them, mark the following:

Pitfall: Getting hit with a large put a tax upon bill when selling your company’s stock.

Suggestion: Make a so-called Section 83(b) election.

Let’s say your company, XYZ Corp., is raising $2 million from investors by issuing preferred stock. As the founder, you get 100,000 shares of common stock valued at 10¢ per interest from your investors through a common arrangement known as reverse vesting. These shares vest more than a four-year period. After year one, you take ownership of 25% of the 100,000 shares. However, the value of the shares is now $1. Good, huh? Maybe not. You see, you now owe private income taxes on the $22,500 carry. What’s more, your company will need to pay federal payroll taxes on this amount.

However, if you had made a so-called Section 83(b) election with the IRS when the shares were issued to you, you could be favored with avoided this problem. The reason is that the stock price bequeath that may be liked have been the same as the fair market value at the time that you received the shares, to such a degree there would be no gain onward the transaction. Bear in mind, you need to send in the 83(b) election form within 30 days of receiving the shares. What is the main exposure to harm involved in doing this? You will settle the original share price to your company because you pleasure have to lever new shares in common stock in order to avoid a tax liability. However, if your company fails, you will let slip through the fingers your cash.

Pitfall: Employees owing a lot of taxes attached stock options.

Suggestion: Prepare a so-called Section 409(A) deferred indemnity hearsay.

Imagine your meeting of friends, ABC Corp., issues a option to an employee to purchase 100,000 shares at 10¢ cropped land (this reward is called the "exercise price"). Then, within a year, the circle sells 1 million shares at $1 per share. The problem for employees comes when they prepare tax returns. The IRS may challenge the exercise reward of the election as conscious below the fair market value. Consequently, an employee may be subjected to ordinary income taxes on the difference between the exercise price and the fair market value as the option vests.

Moreover, under recent IRS rulings, the employee will be subject to an additional 20% in federal tax, and in more cases even additional rank tax. The employee force of will be bound to pay these taxes even admitting that the employee cannot sell the shares. In other words, you are suitable to have some disgruntled employees, what one. could subsist a serious drag on your company.

The IRS does have a solution in the place of this point in dispute. Basically, ABC Corp. be under the necessity of show that it is issuing options that have examples for practice prices that are equal to the fair market value of the underlying shares. "To do this," says Yoichiro Taku, who is a deal attorney at Wilson Sonsini Goodrich & Rosati and the operator of the Startup Company Lawyer blog, "a firm needs to obtain a estimation note that meets the requirements of the IRS." Taku says that it can cost between $5,000 to $20,000 for a valuation report. While this may hardy high, it’s character it in terms of creating employee goodwill for the reason that your employees will subsist saving money on potential tax obligations.

Of course, there are complex rules regarding who can prepare such reports. Essentially, it can be a third-party firm or even an individual within the company, so long as the person has a financial background that meets IRS requirements.

As you can see, in that place are serious tax implications for founders to mark at what time issuing stock. Making a few solution decisions through tax time in mind can save you and your employees a bundle.

Original text: http://www.businessweek.com/smallbiz/content/jan2009/sb2009015_294079.htm?campaign_id=rss_smlbz