Builders and Contractors Exchange
Weekly Bulletin: 03 Jul 2006
Getting A Piece Of The Deal: Pitfalls Of Equity Ownership
By: Christopher Ambrosio
A contractor may, from time to time, be offered a “piece of the deal.” For example, a developer may offer a contractor a certain percentage of equity ownership in a real estate development in lieu of paying for construction services. In another scenario, a valued employee may be offered equity ownership in his employer’s company. These situations raise a number of issues, two of which will be considered here: assessing tax implications from the transaction and obtaining proper documentation of the equity ownership.
Any transaction involving anything of value (called “consideration”) has the potential for tax consequences. Generally, if a person or business receives consideration in exchange for performing services, the consideration received is taxed as ordinary income. This applies whether the consideration is money or equity ownership. Thus, if a developer offers a contractor a certain percentage of ownership of the project in exchange for services, or if an employer rewards a valued employee with equity ownership in the company, the equity ownership received will be taxed as ordinary income. These situations are notoriously complex, primarily because valuation of non-public companies is difficult. A tax advisor should be consulted as to the proper method for reporting this kind of income.
As odd as it may seem, another common problem is tracking the amount of equity that a person may own. Frequently, these types of transactions are informal, done via handshake or with insufficient documentation. Over time, the parties may forget how much each party owns, or disputes may arise on the subject. This is particularly true in companies that do not regularly pay dividends or distributions, as in the early phases of a large development project. If the company is a corporation, stock certificates should be issued specifying the exact number and class of shares. Virginia law provides stockholders with certain rights of inspection of company books and records, including the official list of all stockholders. If the company is a limited liability company (“LLC”) or partnership, less formal documentation is involved. Typically, certificates are not issued (although they can be), and equity ownership is expressed as a percentage, with all the owners’ percentages adding up to 100. The person or company responsible for managing the LLC or partnership must keep track of all the owners and their respective percentage ownership interests. These are typically reflected as an exhibit or schedule to the operating agreement or partnership agreement, as the case may be. Any person or business receiving equity ownership should confirm the amount of ownership at the time of the transaction and at least once annually thereafter.
Equity ownership can offer a person or business tremendous upside potential if the company takes off. However, among many other considerations, the recipient of equity ownership should ask two basic, but often overlooked, questions: (1) will I have to pay taxes on this? and (2) how will I know how much I am getting?
Questions?
If you have any questions about this article or any other related matters, please contact:
This article is meant to bring awareness to this topic and is not intended to be used as legal advice.