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Debtor Strategies for Avoiding Unfavorable Tax
The treatment of loans to a debtor's former employees can result in unforeseen and unfavorable tax consequences. An unwary trustee or administrator of a plan of reorganization (each a 'Responsible Individual') who employs the wrong approach can expose the estate to unanticipated payroll tax liability. Moreover, if the Responsible Individual fails to reserve sufficient funds for payment of such payroll tax liability, he may be forced to pay such liability out of his own pocket. As a result, it is critical that a Responsible Individual be familiar with the issues, and employ the strategies discussed herein.
The Loan Incentive Package
A Responsible Individual's duties under a plan of reorganization often include collection of loans made by the debtor company to its former employees. Frequently, such loans are made as part of a stock incentive program whereby the company loans the employee funds to purchase the company's stock. The loan purchase approach is often favored by employees over a stock option approach, because assuming the stock increases in value as expected, the employee will pay capital gains tax rather than ordinary income tax on the gain. When an employee exercises stock options, the employee must pay ordinary income tax on the difference between the exercise price and the market price at a rate up to 35%. See Treas. Reg. ” 1.83-3(g), 1.61-15(a) (as amended in 2005); I.R.C. ' 1(a-d) (2006); Rev. Proc. 2005-70, 2005-47 I.R.B. 979. By contrast, if the stock loan purchase approach satisfies certain requirements, and the employee holds the stock for a minimum of 1 year, the employee's profit from the stock is treated as capital gain, which is taxed at a maximum of 15%. See 26 I.R.C. ' 1001(a) (2006). In an effort to minimize the risk arising under the loan purchase approach from a potential decrease in the value of the stock, the employer may agree that some portion of the indebtedness will be non-recourse and secured solely by a lien on the stock.
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