Gifts to Employees
Many business owners and some of their advisors believe that making a “gift” of ownership to an employee is an effective way to reward the employee or advance the ownership transfer process. They contend that a gift to an employee can be considered part of the annual gifts that an individual can make (usually called the “annual exclusion”) so that the transfer is not subject to income tax, capital gain or gift tax. They believe that if the transfer is from the business owner personally, and not the company, it will be considered a gift. They are wrong.
In almost all circumstances, a transfer of ownership interest from the business owner to an employee is going to be treated as income to the employee in the eyes of the IRS. The employee is required to pay income tax based on the difference between the value of the property (ownership interest) transferred and the value paid for that property (which is nothing in the case of a “gift”). Not only must income be reported and tax paid on the employee’s tax return, but employment tax withholdings also are required at the time of the transfer.
There are a few situations in which a transfer will be tax-free. These include transfers to the owner’s children who also are employees and transfers of a “profits interest” in a partnership or LLC. Discuss the tax treatment and timing of any transfers of ownership interest with the CPA on your client’s Advisor Team.
For more information on the tax treatment of “property” transferred to employees, look to Section 83 of the Internal Revenue Code and Regulations that are associated with it.