Equity · Taxes

Any reason NOT to use a trust fund to manage equity?

Dimitry Rotstein Founder at Miranor

July 5th, 2015

Even if founders use reversed vesting to minimize taxes, they still have to pay tax if a founder leaves before the vesting period is over and some of his/her shares are taken away (if I understand it correctly, every change in shares' ownership is a taxable event).
Yesterday I heard from a lawyer that founders can assign their shares to a trust fund, in which case shares can be reassigned "virtually", while formally there is no change in ownership - the shares remain in the trust, so there is no taxable event.

Has anyone here tried doing this or saw someone doing this (for founders or early employees who receive substantial options package)?
What can be the downside of using the trust in such a way (besides paying fees to the trust, of course)?

I've never heard of a startup doing this, so there's got to be some limitations or pitfalls here, otherwise everybody would be doing it, right?

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Steve Everhard All Things Startup

July 5th, 2015

The following is offered in the spirit of discussion and should not be taken as legal or tax advice.

You need to talk to a tax advisor but I believe your interpretation of the US tax system on restricted stock is confused. If you are a startup then the best course of action may be a Section 83(b) election to be taxed at the time of transfer of the grant. Any Federal Tax will be calculated in the difference between your grant value and the fair market value of the stock. If these are the same then you won't pay any Federal tax at the time of vesting and the clock starts on treating the asset for capital gains purposes. Any gain you make on resale will be under capital gains rules. If you hold for more than a year this will be long term capital gains tax rates. If you don't make an 83(b) election you may be liable for personal tax at vesting time on the difference  between your vesting price and the fair market value.as it will be regarded as ordinary income. If your shares are not freely tradable on a public exchange this could mean a sizeable tax bill that you cannot recover from share sales. Your calculations for capital gains purposes only begin at vesting time and not at time of transfer.

In the first case, if you have a tax liability and for some reason the shares don't vest (you leave) then you cannot recover any tax you paid at the time of transfer. In the second case (no 83b) then unvested shares incur no federal tax liability.

Despite the Universal Trust Code each Sate has different rules on the creation or operation of trusts. The complexity of what has been proposed to you could be high. The trust can vary the beneficiaries just as a will does, but you need to understand the implications as you remain liable for your tax position regardless of the advice of professional advisors.

Neil Gordon Board Member, Corporate Finance Advisor and Strategy Consultant

July 6th, 2015

Every change in stock ownership is NOT a taxable event. For example, issuing restricted stock (without an 83(b) election is not taxable. Forfeiting those shares is also not taxable. Buying shares at market value is not taxable. Gifting shares (gift tax, if any, aside) is not taxable.

I'm not seeing where an individual's tax situation is changed by owning an interest in a trust that holds company stock vs. an interest in the company directly. No savings in accounting complexity, either, as the simplified company records are offset by the record keeping of the trust.

If there really is a way to avoid taxes on stock transactions that I'm not aware of, I'm all ears! 

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July 6th, 2015

See post from Nolo press.

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July 6th, 2015

Copy Neil Gordon's remarks, input.

Karl Schulmeisters CTO ClearRoadmap

July 6th, 2015

The following is offered in the spirit of discussion and should not be taken as legal or tax advice.

As I understand tax exempt trusts,  they have to have a "social purpose" outside of simple tax avoidance.  And that usually means a whole set of governance overhead.  As has been pointed out, in most pre-public startups, you are carrying enough carryforward liabilities that the "fair market value" calculation of the stock can be done in a way that you incur no tax liability