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I live in the U.S. Suppose that I create a company with a deposit of $10,000 and want to bring in a cofounder for an equity stake of 15% in this company. I have personal assets like computer code, patents, and equipment developed or obtained before founding the company and worth $90,000 in the context of the company. If I give these to the company before I bring the cofounder on board, then the cofounder must pay income tax on $15,000. If, however, I hire the cofounder before these are merged into company assets, and then simply give them to the company as a "gift" (without compensation in stock), then the cofounder pays income tax on only $1500 while everything else remains equal.

The question is whether I am able to take the second approach under any conditions, and if so, what these conditions are. Is there a dependence, for example, on the numbers above, or on the state in which all this takes place?

  • Please be more clear about your assumptions underlying the question. If you issue x shares, representing 15% of the outstanding shares now and then later give the company your tangible and intangible assets in return for more stock, his/her x shares will no longer be 15%. – George White Nov 22 at 16:27
  • @George Thanks for this comment. I have tried to edit the question to be more clear. – SapereAude Nov 22 at 19:41
  • For others that see this question, I would encourage upvotes for at least Jack's and George's answers below (which were both useful and currently have a net negative vote tally). – SapereAude Nov 24 at 11:58
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The short answer is that there is no difference, for tax purposes, in the consequences of transferring the assets to the company before or after a 15% interest is issued to the co-founder.

There is no such thing as a "gift" to a company; the transfer is a capital contribution by one shareholder/member (depending on the organizational form of the company) to the company. The other shareholder/member gets the benefit of the value of the capital contribution (15% of $90,000, in your example).

Depending on the circumstances, that benefit is probably going to be treated as compensation income to the co-founder, just like the 15% of the initial $10,000. If it's any consolation, the company should be entitled to a $15,000 deduction for compensation expenses. If it's an LLC, the co-founder should get the benefit of 15% of that deduction and that should help reduce some of his tax liability.

  • This is also wrong. Hes saying the value of the shares would mathematically affect the taxes. – Putvi Nov 22 at 20:49
  • @Putvi - I have no idea what it means. The value of the shares reflect the value of the assets. So an increase in the assets as a result of the capital contribution increases the value of the co-founder's shares by 15% of the value of the contributed assets - that's taxable income to the co-founder. Don't be so quick to downvote.... – Jack Fleeting Nov 22 at 21:05
  • @Jack Thanks for the answer above (I would upvote it if I could for its clarity). However, since the shares of the cofounder are already granted and vested, I believe any such capital contribution, in so far as it is allowed, would count as capital appreciation and would be subject to capital gains tax at the sale of the shares rather than income tax upfront. Do you have specific evidence to the contrary? – SapereAude Nov 22 at 23:30
  • @SapereAude - run a search for the phrase "capital shift"; it's usually used in the context of partnerships/LLCs, but it applies in the corporate context as well. A capital contribution is not an appreciation of existing company assets, but an increase in the assets from external sources. If things really worked that way, if would be ridiculously easy to convert almost all compensation to capital gain and defer it for years... – Jack Fleeting Nov 23 at 0:32
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I assume you will give your tangible and intangible assets to the company in return for stock in the company. Since there is no particular market value to the stock at or near the point of formation the board could decide that your assets were worth 10,000 shares, for example. When the stock was given in return for those assets, no taxable event would occur since you were trading assets worth X for stock worth exactly X. A company could trade stock for tangible and intangible assets at any point in its existence.

If the new co-founder is not paying "market value" for his/her shares, then they are getting something of value and would need to pay tax on that. I think you are trying to keep that amount low so you would like to do it while the company is worth less. After the assets are transferred to the company it will be worth more. The issue is, will you trade your assets for more stock that the 85% you currently have. If so you will have numerically more shares and the co-founder will have less than 15%. One solution is to figure it out in advance and give the co-founder a large % initially that is then diluted to 15% after you trade stock for your assets.

Based on the edit yo the question - the value of your IP is hard to determine as is the value of the company right after founding. If you provide the IP to the company for 5% of the company (kind of donating) there is no way to say that us not a fair trade.

If you screw up how stock is issued at this point it may be very difficult to ever raise money from professional sources or go public in the future.

  • Really the value of the assets would have to relate to the value of the purchased shares in order to be legal. – Putvi Nov 22 at 19:31
  • Also, you do pay taxes on stock given for services money.com/money/3571313/irs-taxes-stock-you-didnt-buy – Putvi Nov 22 at 19:32
  • @George While I'm after a more complete answer regarding outright gifts, these are great points and I don't think the answer deserves the downvote. I would like to add that a 409A valuation by an experienced firm can give an independent assessment and at least some defensible estimate of the fair market value of a startup. That said, much of any early-stage valuation is subjective. (I give the $90,000 figure above just to make the question simpler.) – SapereAude Nov 23 at 0:17
  • You can donate the IP to the company for nothing in return. By any rational valuation the value of the company goes up. At that point 15% of the company is more valuable hence more taxes for the cofounder. By this logic do it after you issue the cofounders stock. – George White Nov 23 at 5:03
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Different states have different laws regarding corporations and how they distribute stock, but at least here in Illinois, it would depend upon when give yourself the stock and what for.

For tax purposes, the changes would begin when the stock is given. If you have already given yourself stock for the assets, you are too late. The transaction is complete. https://www.sapling.com/7475249/tax-company-stock-lieu-cash

  • the linked article is about stock instead of cash compensation and not particularly relevant. – George White Nov 22 at 18:22
  • It's relevant because it discusses the taxes on being awarded stock for services, imho. – Putvi Nov 22 at 18:23
  • It is a complicated area, the OP's question is unclear and so I take your point that the article has relevance to the topic. - thanks – George White Nov 22 at 18:35
  • @Putvi Interesting first thoughts. Thanks. – SapereAude Nov 23 at 0:26

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