Dividends in lieu of salary

July 18, 2008 10:47 AM

The owner of the small company I work for has suggested that I be compensated in the form of dividends on stock he would let me purchase for a nominal price rather than as regular salary. I would take home the same amount but this would save the company on taxes. Is this legit?

We're a C-Corp and frankly trading water profit wise, I have no problem doing what I can to keep the company going. But I also have no desire to do anything slightly illegal or that will bring the IRS down on me. I'll be consulting an accountant as soon as I get a chance, but would appreciate any thoughts.

posted by anonymous to work & money (19 comments total)

don't know how you could purchase the stock for any price but which it trades at, if public anyway

is this private stock? situation could be different then
posted by Salvatorparadise at 10:57 AM on July 18

I'm not an accountant, but here's my thought:

Is the price that you would be paying for this stock discounted from what it is actually worth (does he even know what it's worth)? Presumably the amount of the discount would end up being taxable income for you (friends of mine at non-public start ups have been in this situation). Since selling some of the stock would probably be hard (plus you would lose part of the dividend), you'd have to come up with that cash out of your own pocket.
posted by NormieP at 11:05 AM on July 18

You will still have to pay taxes on it at some point. It will reduce your FICA salary, which may reduce your eventual Social Security benefits. There are numerous periods of time when you may not trade the stock, because you work for the company, and there are insider trading rules. Who sets the stock value? There are lots of opportunities for you to have trouble, esp. if the company is not doing well.
posted by theora55 at 11:40 AM on July 18

I don't think it's illegal per se (You can reimburse someone just about any way you both agree to, it's called barter) but I suspect that they're up to something shady. At best I think they're trying to transfer the tax liability from the company to you.

You seem to indicate that the company is in danger of failing. I am not an expert by an means, just a guy on the internet, but at first blush it seems a failing company that wants to move you to dividends is trying to screw someone. Either a) they are trying to get around paying you at all. You have to pay them (a small amount of) money to get a chance at dividends (really? Pay to get paid? Is this an email from a Nigerian prince?) And you will then only get paid by dividend. If he says you'll get paid the same amount as your salart he is misleading you, since he can't predict exactly what a dividend will be. Dividends are based on the companies profit. No profit, no dividend, and you've already said they're on think ice profit wise. Or b) They are trying to pay employees out of dividends to dodge creditors, in which case the law will come down on the company, not you. But you probably won't get your entire dividend, they'll be split between the creditors.

Very much get to an accountant. And dust off the resume.
posted by Ookseer at 11:43 AM on July 18 [2 favorites]

IAACPA, and I must warn you that this is not an area of practice I would normally do, but this sounds all kinds of shady to me.

There are questions of valuation here and there may be things you don't know that will hurt you in the long run. Is all the stock owned by just an individual? Does he have a regular audit or just a compilation? The idea of selling off equity seems like a convoluted last gasp at staying a viable company to me.

Maybe time to look for another job?
posted by readery at 11:44 AM on July 18

IANAL, but this also seems like a scheme to avoid paying the corporate 7.5% of your Social Security contribution, corporate payroll taxes, Medicare, etc. If you get laid off, it might also affect your eligibility for workers' comp if your employer is not paying into the system.

What if the corporate board decides to stop paying dividends or decrease the amount paid?

I'd also consult an attorney specializing in labor/employment issues before agreeing to anything.
posted by catlet at 11:44 AM on July 18

My two cents' worth...

No.

It's not that it's not legit to have a dividend-paying stock in a portfolio, and/or in your compensation package, but to have it AS your compensation package is uncommon, at the very least.

Salary/wages include YOUR contributions to FICA (Social Security) as well as the employer's, and these count toward what you earn for retirement income when that distant day arrives. You are losing out on this score, plus on worker's compensation insurance and unemployment insurance, in the event that your employment levels require these two items. (Sometimes, that is not the case with very small companies.)

"Nominal amount" also concerns me. You realize that you are buying into corporate ownership, right? Is that an investment you want to make? Where will the cash for dividends be obtained? Dividend income is taxed at the corporate rate AND your personal rate, but with no witholding. If you are taking home the same amount, multiply that by (1-your marginal tax rate) to see what you are REALLY taking home.

This does not smell good. Avoid it.

If they need you to scam the IRS, things aren't looking too good.
posted by FauxScot at 11:45 AM on July 18

Also, since it's not salary I suspect you'll have a lot less legal protection in the case that the company stops paying you. Management of the company can reduce the dividend to zero anytime they want. Further, if the company tanks you may find yourself screwed when applying for unemployment. They may not view your dividends as "pay" for the purposes of unemployment eligibility.
posted by COD at 11:47 AM on July 18

If your boss is wanting to do this to save money, the company may be in more trouble than you think. Take the salary.
posted by wryly at 11:54 AM on July 18 [1 favorite]

This is a common scheme for the self-employed to avoid Social Security taxes, and the IRS is pretty wise to it. It's hard to prove it being out-and-out illegal, but they routinely reclassify the dividends as regular earnings and charge back taxes, penalties and interest.

I haven't heard of it being tried for an (non-self) employee. Perhaps because it's that much more obvious, or because it's really one-sided in which of the two parties benefits (that would be your employer).
posted by Bokononist at 12:07 PM on July 18

I'll be consulting an accountant as soon as I get a chance, but would appreciate any thoughts.

Get a written opinion from whomever you consult on this matter. That will cover you a bit and also give you ammo for your boss.

Frankly, I wonder if your boss has been paying your half of Social Security/FICA taxes. When things go bad, sometimes they avoid paying these taxes when the pay you. You don't find out for some time.
posted by Ironmouth at 12:25 PM on July 18

If you have to buy stock in order to get paid, then effectively he's going to be paying you with your own money for quite a while.
posted by Class Goat at 12:39 PM on July 18

What Ironmouth said. I've been in that screwjob - and it turned out they weren't paying FICA, Federal OR State income tax, or unemployement insurance. When the company went under and I applied for unemployment, I was told I'd been let go almost a year beforehand. (Boy, was I surprised to find that out.) I then, in rapid succession, got letters from the IRS and the state Department of Taxation about, uh, these missing taxes. (They gave me what looked like perfectly normal W-2s at tax-time.)

I ended up getting unemployment for a bit, as well as getting out of the IRS and state trouble by dint of my mother telling me to never throw out my pay stubs for two years. With those in hand, I proved that they deducted it from me, and the state went after the owners.

Do not get caught in that sort of issue. It took me a solid month, travelling to major state offices and home again on a daily basis, sitting and waiting and talking to people. You may even want to contact these departments now to find out your status.
posted by mephron at 12:48 PM on July 18

It's time to get out.

Even if what the company is doing is perfectly legal and in perfect monetary shape, you will go through such a pain in the ass when it comes time to file your taxes, that it simply isn't worth the hassle.

Sit down with your boss and ask him point blank, "can you afford to pay me in cash." If he stumbles, or tries to come up with alternative solutions, tell him it's time for you to go. It's an unfortunate circumstance, but these things happen all the time, and it is best for both you and him if you leave before payroll starts getting ugly.
posted by mark242 at 1:15 PM on July 18

3rding the guys above. We just had that situation, where the owner didn't pay the IRS or any other state government, and we had to go through what mephron described.

This smells of bad juju. I wouldn't do it.
posted by dejah420 at 1:19 PM on July 18

We're a C-Corp and frankly trading water profit wise,

If your company is treading water, and your boss wants to pay you in shares instead of money, then your boss is basically offering to give you shiny beans instead of money for your work. If you're OK with that, fine, but realised you're effectively taking a pay cut. The shares are most likely worthless.

And , in my neck of the woods, anyway, giving employees shares attracts taxes. Who pays the taxes depends on the mechanism for them; you could also end up owning on nominal gains in value before you've sold the shares and banked the money.
posted by rodgerd at 1:43 PM on July 18

Run. Fast.
posted by rhizome at 1:59 PM on July 18

...end up owning...

That should have been end up owing. (In some places you can be taxed on paper increases on the value of assets.)
posted by rodgerd at 11:37 PM on July 18

I don't see how he gets a tax benefit for paying you dividends as a shareholder as opposed to a salary for which he can deduct anyway.

I would be concerned about facing tax liability for the shares you receive. If you're not giving property for the stock, and really just services, that stock's fair market value might be considered your ordinary income.

On the other hand, if it's legit, qualified dividend income is currently taxed at 15% vs. whatever is your personal income tax rate. This could be good.

There's always the part about the company not declaring a dividend and you not getting paid. You might not even be paid in cash, since they could just issue more stock as a dividend.

This is the sort of stuff you would want to consult a tax attorney for, maybe even a securities lawyer since you said it's a small company. Who are the other shareholders anyway?

Attorneys are better versed in these schemes and could point out more legal issues to be concerned with.
posted by abdulf at 2:06 AM on July 24