Trying to Pay a Sale Bonus to Former Employees After Deal Closes (Seller's Remorse)

[401 Chaos]

Apologies as I'm not sure this is the correct place to post this question but figured folks watching this board would have some good thoughts as you usually do.  Apologies too for the long fact pattern but figure the set up is needed to capture the predicament.  

Client / Seller ( founder / owner) sold her private company to large company earlier this year in an asset deal.  Deal has closed and seller received funds now held in her shell company.  Business had 25 or so employees who all were hired by Buyer and are now employees of a sub in Buyer's group. Seller did not provide any transaction or sale bonuses to employees at closing--had no plan / contractual obligations to do so and failed to build bonuses into the transaction (whereby part of the purchase price might basically have been earmarked for employee bonuses to be paid out by Buyer as part of a post-closing bonus / retention plan, etc.). 

Seller regrets failing to arrange some sort of bonuses and feels strongly about getting something to former employees.  Seller would like to do that in a tiered way so a few very long-term employees get significant amounts.  Some of those individuals are old enough and the anticipated bonus amounts large enough they might result in individuals leaving buyer or retiring if paid all at once. Other, younger employees would still get meaningful bonuses but likely not career-altering.  All former employees would get some amount.

Seller is generous and willing to do this out of proceeds however works but does not want to have to pay tax on the deal proceeds and then pay them out without any deduction and with recipients also getting taxed on the payments.  Seller has thought about just taking cash when distributed from company and making "gifts" to the former employees over some period of time.  Seller would generally be ok doing that but understands the risk such "gifts" to former employees may get characterized as taxable compensation if ever audited.

Buyer is not really interested in helping Seller with her issue or opening the terms of the deal back up.  Seller wonders if there could be a deferred compensation plan of some sort set up by the Seller Company with the bonus amounts contributed to an irrevocable trust and the bonuses distributed over a period of years to the former employees on a schedule the Buyer would not object to as potentially impacting employee retention (e.g., plan would provide for $75,000 per year over 4 years provided employee remained with Buyer rather than giving $300,000 at once) with all amounts due accelerated upon death or disability.  Seller would be fine in having the amounts contributed to trust so they never revert back to Seller and any forfeitures would get allocated among remaining employees and any ultimate remainder (in highly unlikely event there was no remaining employee at the end of 4 years) going to a charity.  In short, Seller would be ok setting up as a completed transfer never to receive any portion back.

While intriguing, it is unclear to me Seller's company would be entitled to an immediate tax deduction (this year) on the amount transferred to an irrevocable trust for distribution to former employees over multiple years.  And, even if that did work somehow, it seems such an arrangement would clearly fail to qualify as a top hat plan since it would cover all former employees (few of whom are highly compensated or management employees).  Seller is not really interested in setting up anything governed by ERISA (if that could even be done) for covering former employees.

Sorry for the long fact patter but hoping somebody may have seen a similar situation and come up with an easy or simple solution that may work.  Thanks for any thoughts. 

[Luke Bailey]

First, make sure the buyer is OK with this and it doesn't violate the sales agreement.

Second, speaking to only the general situation, since the actual facts will be much more complex than you can describe in so short a space, 401 Chaos, I have been involved in similar situations. There is usually a good case to be made in this sort of situation that this is deductible compensation if structured correctly. There is also usually a case that deductibility is at least questionably, because the payments are gifts. Depends on facts and how handled. Usually a gray area.

[401 Chaos]

Luke, thanks very much.  Buyer is OK with concept so long as payments are spread out sufficiently so they aren't likely to have an immediate labor drain (e.g., so over 3 or 4 years).  The employees that would receive the largest payments (most tenured) are nearing retirement age so not really expected to stick around too much longer but Buyer obviously would like to have a few more years from them (or at least be more in control of timing).

Definitely understand this can be a gray area and facts intensive so not possible to fully sort here.  But just to tease out a bit, if I am reading your response correctly, sounds like there may always be at least some risk around deductibility if there is no prior legal obligation to pay?  If that's the case and the owner doesn't mind going the gift route, is that likely the easier and cheaper route?  Seems the IRS cannot challenge them as both gifts and deductible expenses.  If she gets the money, pays taxes, and then just makes straight gifts (while remaining cognizant of not gifting too much too soon or inducing anybody to leave) maybe the ease of that makes most sense.  Certainly seems simpler and cheaper if any approach is going to still leave some meaningful risk.  

[Luke Bailey]

401 Chaos, there is uncertainty on this issue generally, in my experience, but I would point out that IRC Section 102(c) says that an employer cannot make a gift to an employee, i.e., it's always compensation if payment is from employer to employee. So it's complicated and depends in part on who is making the payment. Your client should definitely discuss this with its CPA and if they need further help, get legal advice for specific situation.