Can I Make Tax Free Gifts of Stock to My Employees?

Q: I am a founder of a corporation. I would like to make gifts of stock to my employees in consideration of services they’ve rendered to the company. Can I make gifts of stock to them that are not taxable as compensation because they are gifts directly from me?

A: No. In the context of an employer and an employee relationship, it is virtually impossible to make a nontaxable “gift” for federal income tax purposes.

If a founder “gives” stock to his employees in consideration of services rendered to the company, the transaction is treated as if the founder had transferred the stock to the company, and the company had then issued the stock to the employee–triggering income and employment tax withholding. See Treasury Regulation quoted below.

Sec. 1.83-6 Deduction by employer.

(d) Special rules for transfers by shareholders–

(1) Transfers. If a shareholder of a corporation transfers property to an employee of such corporation or to an independent contractor (or to a beneficiary thereof), in consideration of services performed for the corporation, the transaction shall be considered to be a contribution of such property to the capital of such corporation by the shareholder, and immediately thereafter a transfer of such property by the corporation to the employee or independent contractor under paragraphs (a) and (b) of this section. For purposes of this (1), such a transfer will be considered to be in consideration for services performed for the corporation if either the property transferred is substantially nonvested at the time of transfer or an amount is includible in the gross income of the employee or independent contractor at the time of transfer under Sec. 1.83-1(a)(1) or Sec. 1.83-2(a). In the case of such a transfer, any money or other property paid to the shareholder for such stock shall be considered to be paid to the corporation and transferred immediately thereafter by the corporation to the shareholder as a distribution to which section 302 applies. For special rules that may applyto a corporation’s transfer of its own stock to any person in consideration of services performed for another corporation or partnership, see Sec. 1.1032-3. The preceding sentence applies to transfers of stock and amounts paid for such stock occurring on or after May 16, 2000.

(2) Forfeiture. If, following a transaction described in paragraph (d)(1) of this section, the transferred property is forfeited to the shareholder, paragraph (c) of this section shall apply both with respect to the shareholder and with respect to the corporation. In addition, the corporation shall in the taxable year of forfeiture be allowed a loss (or realize a gain) to offset any gain (or loss) realized under paragraph (b) of this section. For example, if a shareholder transfers property to an employee of the corporation as compensation, and as a result the shareholder’s basis of $200x in such property is allocated to his stock in such corporation and such corporation recognizes a short-term capital gain of $800x, and is allowed a deduction of $1,000x on such transfer, upon a subsequent forfeitureĀ of the property to the shareholder, the shareholder shall take $200x
into gross income, and the corporation shall take $1,000x into gross income and be allowed a short-term capital loss of $800x.

About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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