Key Employee

Technical topics regarding tax preparation.
#51
DAJCPA  
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Curious as to the tax basis journal entries on both the original shareholder's and the corporation's books for the 30% given to Key Employee?
 

#52
Nilodop  
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Original s/h keeps his tax basis in the remaining shares, so the only "entry" is a memo to reduce his number of shares. Corporation shows treasury stock at zero cost, then shows issuing it at a gain equal to the value of the compensation, said gain being not taxable because of section 1032.
 

#53
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Section 83(h) only "denies the deduction to the shareholder" if the s/h is NOT


Right. But it’s a given that the key employee isn’t performing services for the shareholder.
The regulation is simply stating what Congress intended as set forth in the Senate Report.


The plan in question isn’t a restricted stock plan. But even if we bypass that point, which isn’t so insignificant, the Regulation is still problematic because it’s in direct conflict with Sec 1001. It’s hard to see how a Regulation, which is supposed to deal with the limited issue of income and deduction with respect to a transfer of stock, ends up superseding an existing Code Section pertaining to gain and loss. Just because the Treasury wrote the regulation based on what Congress intended, doesn’t mean the Regulation passes muster. What if the Senate Report also said that the Senate believes all gifts and muni bond income should be taxable, and directs the Treasury to write a Regulation to that effect, which the Treasury does. That Regulation would be good to go?
 

#54
Pitch78  
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Nilodop wrote:Yes, Pitch 78, what you say is true. But please, Pitch, don't get Jeff started on what this means:
The parent company or the shareholder merely is to reflect the contribution as an increase of the equity in the company which is entitled to the compensation deduction.


That is verbatim from the legislative report. I would like to hear Jeff's take.... :twisted: :twisted: :twisted:
 

#55
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I didnt see Jeff's reply. The specific controls over the general. 83h addresses a specific transaction, and is pretty much an exception to 1001. It gives the deduction to the corporation, so you have to figure out how the corp got the stock when it was never in title. For a 100% owner, seems that 351 could also apply and not 1001. Regardless, it is the specific controls over the general, and the legislative history fills in the gap of the intention of the legislature on how that fiction works with the language in the statute.

Re muni bonds and gifts, your example is too broad. It is comparing apples to oranges.
 

#56
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Re muni bonds and gifts, your example is too broad. It is comparing apples to oranges.


Not really, because if we have Code Section that says a sale or exchange gives rise to recognized gain or loss (i.e. Sec 1001), it’s hard to see how a regulation in a different Code Section could trump that…especially when that other code section [Sec 83(h)] doesn’t preclude shareholder gain/loss recognition. All Sec 83(h) covers is the EE’s income recognition and the corporation’s deduction. As such, the regulation sure seems to go beyond those points. It’s still over-reach even if Congress intended over-reach. You can’t undo a statute with a regulation. If you could, why doesn’t the IRS just issue a Regulation telling us that QIP is 15-year property?

Regardless, it is the specific controls over the general


There is no “general” in Sec 83(h) as to shareholder gain/loss recognition. All we have are “specifics” in the Regulation…which over-ride a completely different Code Section.

Or, we might say that the “general” in Sec 83(h) is that it doesn’t upset Sec 1001…if so, then the “specifics” completely over-ride that idea…
 

#57
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Let's say you're right, which I don't yet concede. Why hasn't it come up in cases, rulings, scholarly articles, etc? And, in your facts. What will be your advice to them? I think you said your firm does the 1120S. Will the result be a gain to the s/h, whose return I gather your firm is not concerned with, but still the same deduction by the corp.? Is there an inconsistency between reporting it as a sale to the corp., but based on its being a satisfaction of a compensation liability? Im not expressing it well, but you get the idea, i think. A taxed gain and no benefit from the added basis.
 

#58
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It has come up in cases though 1001 is not mentioned.

https://www.ravellaw.com/opinions/8d5d1 ... 8c42430d9e

Jeff is arguing the position the Tax Court took, which was reversed on appeal.
 

#59
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Really nice find, Pitch. Thanks. Nichols' dissent is entertaining if not persuasive. I just reviewed Jeff-Ohio's
TPT profile, hoping to ascertain whether he had possibly been one of Judge Nichols' law clerks back then, as Jeff's reasoning was similar to Nichols', but I'm unable to conclude.
 

#60
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Nichols' dissent is entertaining if not persuasive.


I found the whole issue to be pretty fascinating. Here, in the Senate Report, we have a indication of Congressional intent, but the existing statutes are at odds with that intent. The existing statute [Sec 83(h)] says nothing about the shareholder’s gain or loss. And another existing statute, Sec 1001, tells us that gain/loss is recognized by the shareholder. Yet, some words show up in a Senate Report that say, “Our intent is to expand Sec 83 so that it says stuff it doesn’t say (about a completely different area of the law) and to also to create an exception to that completely different area of the law (Sec 1001).”

I’d say the dissent is pretty persuasive. And I wonder how this would pan out in another circuit.

With that said, here we sit with Congress screwing up the new law as to Qualified Improvement Property. It is clear Congress intended for such property to have a 15-year life, such that it would qualify for bonus depreciation. Doesn’t Tilford tell us that the Treasury has all the authority in the world to just issue a Regulation that says, “QIP has a 15-year life?” I mean, if all we need is a manifestation of Congressional intent, why isn’t that good enough?

Is the Treasury worried that certain Congresspeople would get mad at them?

P.S. You ought to read the Tax Court case too:

https://casetext.com/case/tilford-v-com ... al-revenue
 

#61
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I agree to some extent....but

The statute creates a fiction. Deduction to the corp for stock it doesnt own. So the question is the other part of the equation. Obviously Congress thought it would be a simple capital contribution and apparently subject to 351 regardless of control. My take on it is that if you are going to give the corp the deduction, as 82h does, then the corp is the one that gave the stock. For that to happen, the regs fill in the gap. Basically, a substance over form argument.

Curious, in Jeff's case (and maybe you already said) but did the client actually transfer his shares to employee or did the corp simply issue new shares?
 

#62
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Curious, in Jeff's case (and maybe you already said) but did the client actually transfer his shares to employee or did the corp simply issue new shares?


He transferred his shares to the Key Employee.
 

#63
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Lawyer/CPA Gordon F. Litt wrote this not that long after the 6th Circuit reversed the Tax Court. Since Jeff's situation is (I assume) in that Circuit, I just thought I'd post this for its relevance to his facts and for completeness. https://kb.osu.edu/bitstream/handle/181 ... 4_1041.pdf

And this to show the difference where the stock goes to the corporation, not the shareholder (and stays there). https://www.leagle.com/decision/198424583ktc1621235. So, following Frantz, there are different tax results in these two situations that have the same economic effect. Say I own 60 shares and employee owns 40 shares of a corporation. We are the only shareholders. Employee says he'll leave unless he gets to be a 50% s/h. My choice to keep him could be to transfer 10 of my shares to employee, (squarely fitting 1.83-6(d)), or to transfer 20 of my shares to the corporation, (squarely fitting Frantz).
Last edited by Nilodop on 18-Jan-2019 10:01am, edited 1 time in total.
 

#64
Pitch78  
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In both cases, the transferring shareholder has no tax consequences.

If the intent of the redemption is to compensate the employee, I dont see a reason why 83(h) would not apply. The corp only gets a deduction for the amount includible in the employees income.
 

#65
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In both cases, the transferring shareholder has no tax consequences. . Jeff can comment on that, this being the thrust of his OP.

If the intent of the redemption is to compensate the employee, .... What redemption?
 

#66
Pitch78  
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The stock going to the corporation.
 

#67
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I tend to think that, no matter how you slice it in a small business setting involving a Key Employee (OP facts or Post #63 facts), Sec 83(h) and the -6 Regulation would likely be invoked.

Bear in mind that Sec 83 uses the words, “in connection with the performance of services.” The actual transfer doesn’t have to be compensatory. In Post #63, Nilodop says the transfer was to be effected because the Key Employee said he’ll leave absent 50% ownership. A case could be made that the surrendering shareholder surrendered his shares exclusively to protect his own investment…and that the Key Employee wanted additional ownership so that his vote counted just as much as the surrendering shareholder. However, I think it’s a hard case to make that the surrender was not in connection with the performance of services. Someone might say that the Key Employee is the manager that provides services on a day-in and day-out basis…and the surrender was made so that said services would continue to be provided. In other words, while the protection of investment is a valid argument, and while the employee’s argument is valid all the same (I wanted more say so in the business), the fact remains: The transfer was also “in connection with the performance of services.”
 

#68
Pitch78  
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Jeff, I think that sums it up pretty good.
 

#69
Nilodop  
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I don't.

Section 83
(a) General rule If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, ...


Section 83
(h) Deduction by employer
In the case of a transfer of property to which this section applies or a cancellation of a restriction described in subsection (d), there shall be allowed


Reg. 1.83-1
(a)Inclusion in gross income -

(1)General rule. Section 83 provides rules for the taxation of property transferred to an employee or independent contractor (or beneficiary thereof) in connection with the performance of services by such employee or independent contractor.


Reg. 1.83-6
(a)Allowance of deduction -

(1)General rule. In the case of a transfer of property in connection with the performance of services, ... a deduction is allowable under section 162 or 212 to the person for whom the services were performed.


I'd say that, where the transfer is from the s/h to the corporation, it's not within 83(a) and its reg., so 83 (h) and its reg. do not apply. 1.83-6 has to be read with 1.83-1 in mind.

From post #63: My choice to keep him could be to transfer 10 of my shares to employee, (squarely fitting 1.83-6(d)), or to transfer 20 of my shares to the corporation, (squarely fitting Frantz).. Two different transfers. We'd need to have an argument that the transfer to the corporation, and no further, is in substance an indirect transfer of property to the employee. It does have the same effect, but that argument was not made in Frantz and I have not come across it in this context elsewhere. It might apply, and surely has been made successfully in other contexts.
 

#70
Pitch78  
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I think substance over form would prevail. Plus, something was transferred to the employee. His ownership in the company increased.
 

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