I’ve had my Internet service business for two years, and I recently found a partner with strong sales skills. She’s asked for 25 percent of the company upon joining and for stocks, which I think is steep. What should I do?
You face a common problem with a fair solution. Because you’re granting stock-related compensation, income taxes are based on the value of the shares at the time of grant. If there are vesting restrictions, the IRS allows recipients of stock grants to delay reporting until the shares are owned “free and clear.”
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But there’s a risk of growing tax liability. For example, if you award 100,000 shares that vest in equal installments over five years, then your marketing manager pays taxes based on the current value of 20,000 shares — not their value when she joined your company. If your company grows steadily, then her annual tax bite for earning 20,000 shares of stock will increase. There’s a way to cap her tax bill, however.
The IRS allows stock recipients to pay taxes on their entire allotment of shares up front, though the shares remain restricted due to vesting requirements. Stock recipients who bet that the company’s shares will increase in value over time have 30 days from the date of stock grant to submit the "83(b) election" form to the IRS. Some states may have additional requirements, so it’s best to consult an accountant.
You shouldn’t award any shares without vesting requirements. You can structure the vesting terms based on time served or achievement of certain goals. It’s important she earns her stake in your company.
Don’t give it away! Finally, have your attorney incorporate an optional share buyback clause into the agreement in case she leaves the company.