Discussion:S Corp-Management fee/Sweat Equity
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Discussion Forum Index --> Advanced Tax Questions --> S Corp-Management fee/Sweat Equity
Discussion Forum Index --> Tax Questions --> S Corp-Management fee/Sweat Equity
| 22 December 2007 | |
| One shareholder owns two S Corps. In Corp 1, he performs daily services and receives {reasonable} compensation (W-2).
Corp 2, he hires someone to work and offers the employee a "sweat equity" payoff. Net income is split 50/50 every month. 50% to employee as a monthly salary bonus and the other 50% goes to reduce the "sweat equity" balance. When balance gets to zero, the business is transferred to the employee. As called for in the contract, shareholder receives a monthly "management fee" for his "managerial acumen" to be deducted before the net income is calculated. Three questions I am debating:
Sorry for the multiple question post, but I wanted to post this before I keep reviewing his returns and Question 4 arises.... | |
| 22 December 2007 | |
| How do you classify the monthly payments for an equity interest? Are they refundable? Seems like you may be creating a second class of stock, | |
| 22 December 2007 | |
| I am not sure I follow your question. The monthly payment for the "management fee" does not have anything to do with the "sweat equity" balance and the employee receives his share of monthly net income via W-2 wages. | |
| 22 December 2007 | |
| What do you mean by the statement: "the other 50% goes to reduce the "sweat equity" balance"? After payment of wages & attendant PR taxes, the result is net income. If by your statement you mean that the BIG KAHUNA shareholder takes a distribution of the net income, then you have a disproportionate distribution, assuming the SweatEquity guy has already been issued stock in the same number as the Big Kahuna guy. You need to clarify your question. | |
| 22 December 2007 | |
| My point is the same as JD's. He who sweats must recognize income for what he gets. In the scenario you outline, the worker is getting a reduced salary in exchange for what? What does he have after month one? | |
| 22 December 2007 | |
| Sorry. The employee is not a shareholder and is not issued any stock until the balance of sweat equity is zero, so no disproportionate distributions.
For example assume the sweat equity balance is $75000 and Year 1 net income (before bonus) is $80000. $40,000 would be added to his W-2 as a bonus and the remaining $40,000 would go to reduce the balance of sweat equity to $35000. | |
| December 22, 2007 | |
| Shareholder should receive a W-2 for his management services. How do you determine what is the beginning balance of the "sweat equity" account? What's your journal entry for the sweat equity each month? Debit what? Credit what?
Does the seller have the right to fire the sweaty worker when there is only $1000 of sweat equity balance left to eat up? I doubt it. It sounds like a quid pro quo arangement. i.e. if you work, I promise to issue stock at some point in the future. I expect the promise would have the same value as actually holding the shares. Or as Dennis says, it would create a second class of stock. I agree that, YES, he must be issued a 1099 for the value of the sweat equity services provided. What happens if there is a loss? Have you considered the department of labor rules related to minimum wage? What happens if he dies after chipping away 90% of the sweat equity balance? What happens if he falls off a ladder after earning 80% of his promised equity, and he can't do the job anymore? What happens if you fire him because you think he's running the business into the ground? Kindly fill out your profile. Many thanks. | |
| 23 December 2007 | |
| He is an employee. Value of the sweat equity is taxable W2 compensation, not 1099 income. | |
