Stock repurchase as condition of severance

[Sebastian23]

Hello all, 

This is a rather complex one. 

Suppose an employee has a separation agreement that entitles him to 50% of his annual salary in a lump sum. Employee is also entitled to equity in the company (25% is vested upfront, and 75% with accelerated vesting upon termination for any reason). 

The parties agree that, in lieu of receiving the lump sum severance payment and other benefits, the company will repurchase 75% of the stock held by employee at a predetermined price, on a pre-determined future date (after the 1 year capital gains date). 

1) Upon signing the separation agreement now, would the employee be in 'constructive receipt' of the cash from the repurchased stock, or would receipt only occur when the cash hits his account? This matters for the 1 year capital gains treatment, which occurs 2 months after the separation agreement will be signed. 

2) Also, would cash from the repurchase of employee's stock be taxable as capital gains or ordinary income? This transaction would be arranged as a stock transfer agreement, but the purchase price would be set in the separation agreement, and is binding upon the employer. 

Many thanks for your help!

[Luke Bailey]

Sebastian23, of course your description of the facts is pretty slim. The existence of a buy-sell, right of first refusal, etc. could affect. Taking at face value what you have provided, and treating it as a hypothetical, since again many past facts have been omitted, and the future facts (e.g., how the deal is written) are unknown, it appears that the employee was awarded real stock and will now be vested in all of it, so if he or she eventually sells it, I would think the form of the transaction as the sale of a capital asset would be respected. I think the key problem in what you have described is the pre-determined price. Under the 83 regs, which do not provide a bright line test, the service provider has to have the risks and rewards of ownership in order for the stock to be treated as having been transferred. And of course, the employee will be taxable on the current FMV of the stock now, which value will be his/her basis. But again, I am just addressing a hypothetical subset of the issues, for illustrative purposes.

I guess there is the potential for a 409A "substitute payment" issue, but although, again, you do not provide sufficient facts, it would appear the severance payment would qualify for the short-term deferral exception.