NQSO - W2 withholding

[Guest Shrek'sconfused]

Hello

Day 1 - I exercise my NQSOs. I now own 50% of the company.

Day 2 - We sell the company for $20m, $2 M being held back.

My W-2 income reflects the $9m SP as the FMV of my NQSO (less exercise price).

Year 2 - escrow is released. I think this is W-2 income. But the company's been acquired.

Is this W-2 income? If so, can you provide authority?

Who issues the W-2? The accquiring company doesn't want to.

[jpod]

First, you are assuming that the shares you acquired upon exercise are worth $10MM, but that may not be the case depending upon the likelihood that you and the other shareholder(s) will actually receive the escrow. (For example, is the escrow subject to a difficult earn-out condition, or is there pending litigation which causes the true FMV to be less than $20MM?)

Let's assume your shares are in fact worth $10MM. In that case, upon exercise of the NQSO you take a tax basis in the shares of $10MM. The $9MM you receive as sales proceeds on Day 2 is not compensation or reportable on a W-2. Similarly, anything you receive out of escrow is sales proceeds and not compensation.

[Guest Shrek'sconfused]

Thank you. This is an indemnification escrow to protect buyer from possible litigation.

I've seen it treated where the Gain of 9m - cost gets on W-2.

Year 2 - the additional 1M makes it on the W-2 from the acquiring company.

And then SP = CB on schedule D. I've found this to be the scenario used in several cases.

Just looking for authority to explain why this is done. I'm thinking 409A, but not sure how I get there.

First, you are assuming that the shares you acquired upon exercise are worth $10MM, but that may not be the case depending upon the likelihood that you and the other shareholder(s) will actually receive the escrow. (For example, is the escrow subject to a difficult earn-out condition, or is there pending litigation which causes the true FMV to be less than $20MM?)

Let's assume your shares are in fact worth $10MM. In that case, upon exercise of the NQSO you take a tax basis in the shares of $10MM. The $9MM you receive as sales proceeds on Day 2 is not compensation or reportable on a W-2. Similarly, anything you receive out of escrow is sales proceeds and not compensation.

[jpod]

Payment received in exchange for stock from the buyer is a capital transaction, whether it occurs five years or five minutes after exercising the stock option. IN no way should any amount received from buyer be treated as W-2 under these circumstances. 409A is irrelevant.