employee v. partner - · pdf file10 llc membership units $200 appreciated assets ... issuance...
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EMPLOYEE V. PARTNER
Entrepreneurial Risk Permanent or Transitory Status
Related to the Performance of ServicesTax MotivatedRelative Size
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MEMBER AS EMPLOYEE
Employment Taxes: withholding vs. quarterly estimated tax payments and self-employment tax
Timing: K-1 vs. Wages when received
Character: pass through vs. always ordinary
Benefits for employees: Health Insurance
Meals and Lodging Cafeteria Plan Fringe Benefits
Group-Term Life Insurance
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Employees
W-2 Compensation& Benefits
LLCInterestLLC
Operating Company
EmployeeLeasing Sub
Services
Employee Leasing Company Structure
Fees
Cash
* Compare Equity Appreciation Plan
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CODE SECTION 83
Service provider recognizes ordinary income on account of the transfer of property when the property vests
Ordinary income is difference between FMV at each vesting date and amount paid for the property
Service provider may file an 83(b) election, and elect to recognize ordinary income equal to the difference between
the transfer-date FMV and the amount paid
Service provider will want to make 83(b) election if he or she paid FMV for property and/or its value will appreciate
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REV. PROC. 2001-43IRS will not tax service provider (SP) or the partnership
on grant of a non-vested profits interest if:
* The partnership and SP treat SP as the owner of the partnership interest from the date of grant;
* Neither the partnership nor any of the partners deducts any amount for the fair market value of the interest; and
* All other conditions of Rev. Proc. 93-27 are satisfied:
- interests relating to a substantially certain and predictable stream of income,
- interests disposed of within two years of receipt, and - interests in publicly traded partnerships.
No Section 83(b) Election Required
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REV. PROC. 2001-43ALLOCATION OF INCOME AND
DISTRIBUTIONS
Non-Service Partners
Yr. 1 Income $90 Yr. 1 Distributions $90
Service Partner
Yr. 1 Income $10Yr. 1 Distributions $10
10% Non-vested profits interest granted to SP$100 of allocable Income
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ALLOCATION OF INCOME AND DISTRIBUTIONS
PROFITS BONUS ALTERNATIVE
Non-Service Partners
Income $100 Comp Deduction ($10)
Distributions ($90)
Service Partner
Compensation $10
* Unfunded, Unsecured Equity Appreciation Right
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CAPITAL VS. PROFITS INTERESTNO BOOK UP
Capital Accounts ofNon-Service Members $1,000
Net Fair Value of LLC’s Assets $2,000
10% Profits Interest Granted to Service Member
Capital Accounts
Non-Service Members $1,000Service Member 0
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CAPITAL VS. PROFITS INTERESTNO BOOK UP/ SALE OR LIQUIDATION
Capital Accounts ofNon-Service Members $1,000
Net Fair Value of LLC’s Assets $2,000
10% Profits Interest Granted to Service Member
Proceeds
Non-Service Members $1,900Service Member 100
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CAPITAL VS. PROFITS INTERESTBOOK-UP
Capital Accounts ofNon-Service Members $2,000
Net Fair Value of LLC’s Assets $2,000
10% Profits Interest Granted to Service Member
Capital Accounts Book Tax
Non-Service Members $2,000 $1,000 Service Member 0 0
Treas. Reg. Sec. 1.704-1(b)(2)(iv)(f)
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NON-VESTED CAPITAL INTEREST
ServiceMember (10%)
Non-ServiceMembers (90%)
TaxableIncome (Distributions) (Distributions)
TaxableIncome
0 0$90 $10
90/10 Members - Service and Non- Service contribute $90/$10Service Member vests in 5 years
LLC has income of $100 in year 01$100 Distribution in year 2
Year 1
Contributions Contributions
1/1/01 $90 $10
Year 2 $90 $10
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NON-VESTED CAPITAL INTEREST
ServiceMember (10%)
Non-ServiceMembers (90%)
TaxableIncome (Distributions) (Distributions)
TaxableIncome
0 0$100 $0Year 1
Contributions Contributions
1/1/01 $90 $10
Year 2 (10) $90 $10 Guaranteed Payment
Same facts as previous illustration - no 83(b) election
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REPURCHASE OF 100% OF CAPITAL INTEREST
SECTION 83(B) ELECTION
Capital AccountNon-Service Partners
1/1/2001 $90 Yr. 1 Income $90
Yr. 1 Distributions $0 Yr. 1 Capital Acct $180
!/1/2002 Repurchase at Cost
Capital Shift $10 Ending Cap Acct $190
Capital AccountService Partner1/1/2001 $10
Yr. 1 Income $10Yr. 1 Distributions $0Yr. 1 Cap Acct $20
Distribution ($10)Forfeited ($10)
Ending Cap Acct $0Capital Loss $10
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REPURCHASE OF 80% OF CAPITAL INTEREST
SECTION 83(B) ELECTION
Capital AccountNon-Service Partners
1/1/2001 $90 Yr. 1 Income $90
Yr. 1 Distributions $0 Yr. 1 Capital Acct $180
Repurchase 80% at Cost
Capital Shift $2Ending Cap Acct $182
Capital AccountService Partner
1/1/2001 $10Yr. 1 Income $10
Yr. 1 Distributions $0Yr. 1 Cap Acct $20
Distribution ($8)Forfeited ($2)
Ending Cap Acct $10
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FORFEITURE OF CAPITAL INTEREST
Capital AccountService Partner
1/1/2001 $10Yr. 1 Income $10
Yr. 1 Distributions $0Yr. 1 Cap Acct $20
Distribution $8Forfeited $2
Ending Cap Acct $10
SP’s Tax BasisContribution $10
Income $10Distribution ($8)
Basis $12
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GRANT OF LLC OPTION
$1,000 FMV$1,000 Capital Accounts
Founders
LLC
ServiceProvider
Exercise Price $10 per UnitFair Value at Grant Date $10 per Unit
Total Exercise Price $100
Option on 10 LLC Membership Units
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CAPITAL ACCOUNT ANALYSIS – GRANT OF OPTION
Capital Accounts
Founders Service Provider
Book Tax Book Tax
$1,000 $1,000 0 0
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EXERCISE OF LLC OPTIONFounders
LLC
ServiceProvider
Exercise Price $10 per UnitFair Value at Exercise Date $20 per Unit
Total Exercise Price $100
10 LLC Membership Units$100
$2,000 FMV$1,000 Capital Accounts
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EXERCISE OF LLC OPTIONCONSEQUENCES TO OPTIONEE - NO BOOK UP
Founders
LLC
ServiceProvider
Exercise Price $10 per UnitFair Value at Exercise Date $20 per Unit
Total Exercise Price $100
10 LLC Membership Units$100
Optionee's Capital Contribution $100Optionee's share of deemed
liquidation proceeds (Rev. Proc. 93-27) $200Compensation income (sec. 83 or 721) $100
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ALLOCATION OF DEDUCTION
ServiceMember (10%)
Non-ServiceMember (90%)
Taxable Income(Deduction) Resulting
From Issuance $100($100)
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SPECIAL ALLOCATION OF DEDUCTION
ServiceMember (10%)
Non-ServiceMember (90%)
Taxable Income(Deduction) Resulting
From Issuance$100
($100)
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EXERCISE OF LLC OPTIONCONSEQUENCES TO LLC - ASSET RECONTRIBUTION
MODEL
LLC
Exercise Price $10 per UnitFair Value at Exercise Date $20 per Unit
Total Exercise Price $100
Fair Value of 10% of Assets $200 SP’s Basis $200Basis in 10% Assets $100 SP’s Cap Acct $200
Gain on deemed exchange $100Compensation Deduction $100
ServiceProvider
10 LLC Membership Units
$200 Appreciated Assets
$200 Assets
$100 Cash & Services
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CAPITAL ACCOUNT ANALYSIS: OPTION EXERCISE; ASSET RECONTRIBUTION MODEL;
NO BOOK UP
Capital Accounts
Founders Service Provider
Book Tax Book Tax
Original $1,000 $1,000
Gain on
Deemed Sale 100 100
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CAPITAL ACCOUNT ANALYSIS: OPTION EXERCISE; ASSET RECONTRIBUTION MODEL;
BOOK UP
Capital Accounts
Founders Service Provider
Book Tax Book Tax
Original $1,000 $1,000
Gain on Deemed Sale 100
Compensation (100) (100) $100
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EXERCISE OF LLC OPTIONCONSEQUENCES TO LLC - CASH COMPENSATION
MODEL
LLCServiceProvider
Exercise Price $10 per Unit SP’s Comp $100Fair Value at Exercise Date $20 per Unit SP’s Basis $200
Total Exercise Price $100 SP’s Cap Acct $200
Section 83(h) Deduction of $100
10 LLC Membership Units
$100 Compensation
$200 Cash
Services
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CAPITAL ACCOUNT ANALYSIS: OPTION EXERCISE; CASH COMPENSATION MODEL; NO
BOOK UP
No Book Up on Exercise for 10 Units
Capital Accounts
Founders Service Provider
Book Tax Book Tax
$1,000 $1,000
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CAPITAL ACCOUNT ANALYSIS: OPTION EXERCISE; CASH COMPENSATION MODEL;
BOOK UP
Book Up on Exercise for 10 Units
Capital Accounts
Founders Service Provider
Book Tax Book Tax
Original $1,000 $1,000
Compensation (100) (100)
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ISSUANCE OF NON-COMPENSATORY LLC WARRANT
Founders
LLC
Vendor, Lenderor Landlord
Exercise Price $10 per UnitTotal Exercise Price $100
LLCWarrant
Value of Warrant ??OID, Rent, Sales Proceeds
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EXERCISE OF NON-COMPENSATORY LLC WARRANT
LLC
WarrantHolder
Exercise Price $10 per UnitTotal Exercise Price $100
10 LLC Membership Units$100
$2,000 FMV(post-exercise)
Existing Partners' Warrant Holder'sCapital Accounts Capital Account
(90 Units) (10 Units)Before
Exercise $1,900 0After
Exercise $1,800 $200
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EXERCISE OF WARRANTCAPITAL SHIFT
Capital Accounts
Founders Investor
(90%) (10%)
Book Tax Book Tax
Original
Contribution $1,000 $1,000 $100 $100
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EXERCISE OF LLC WARRANT AFTER SALE OF ASSETS
WarrantHolderLLC
$2,000Cash ($1,900 from sale of assets, $100 from Investor)
$100
10% Interest
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CAPITAL ACCOUNT ANALYSIS - EXERCISE OF LLC WARRANT AFTER SALE OF ASSETS
Founders Investor
(90%) (10%)
Book Tax Book Tax
Original
Contribution $1,000 $1,000 $100 $100
Gain on sale 900 900
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CONVERTIBLE DEBT ISSUANCE
Debt-holder$$
Convertible DebtInstrument
Vs.
Debt with Warrants
LLC
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DEBT CONVERSION
Debt-holderDebt
LLC LLC Interest
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CONVERSION OF PREFERRED LLC INTEREST
LLC
Preferred InterestHolder
10 LLC Membership Units
$2,000 FMV
Common Holders’ Preferred Holder'sCapital Accounts Capital Account
(90 Units) (10 Units)Before
Convert $1,900 $100
After Convert $1,800 $200
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CAPITAL ACCOUNT ANALYSIS – CONVERSION OF PREFERRED LLC INTEREST, SALE BEFORE CONVERSION
Common Preferred
Book Tax Book Tax
Original
Contribution $900 $900 $100 $100
Gain on Sale $1,000 $1,000 0 0
Balance $1,900 $1,900 $100 $100
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LLC INCORPORATION
LLC
A B
The Operating agreement provides that distributions are made 80/20 until A's capital account is reduced to zero, and then 50/50.
Alternative 1: NewCorp issues common stock to A and B in the ratio of profits percentages (50/50)
Alternative 2: A receives preferred stock and B receives common stock, thus preserving A's preferential distribution rights.
Note Section 351(g) issues for non-qualified preferred stock.
Capital Account Profits Percentage
Member A $800 50%Member B $200 50%
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OPTION AND LLC INTEREST ASSUMPTION
LLC
Optionees &Interest Holders
NewCorp
NQSO’s
LLC Interests
Significant Tax Issues:
ISO Status of NewCorp Options (Code sec. 422(b)(4); 424(a); 424(h)(3)(A))New Holding Period
Deemed Exercise of NSO's
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LLC INTEREST ASSUMPTIONPOST EXERCISE
LLC
Optionees &Interest Holders
NewCorpCommon
Stock
LLC Interests
Significant Tax & Legal Issues:
Section 351 property and compensatory transfer issues
Securities Issues (Federal Rule 701; California 25102(o) or (f))
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CORPORATE PARTNER EQUITY COMPENSATION
A Corp B Corp
AB, LLC
A Corp Stock and $100 cash
A Corp StockEmployee
of ABFMV $100
$50 CashEmployee has $50 incomeA Corp has 0 gain or loss
AB has deduction
$100