Sweat equity shares refer to company shares offered to employees or directors at a discount or for non-monetary contributions. Though sweat equity itself is not taxable, selling sweat equity shares for profit makes the proceeds taxable.
Tax Implications
IRS treats sweat equity shares as two transactions – labor provided to the company, and compensation in the form of shares. If no money is paid, labor is exchanged for shares, making shares taxable compensation.
- Valuation: Sweat equity share value is set by a merchant banker.
- Taxability Period: Taxability applies within 180 days from the date of exercising the share option.
- Conditions for Taxability: Shares allotted or transferred to employees in the same year.
Agreements and Valuation
Shareholders should have agreements limiting the possibility of disagreements over partner contributions. Information to include:
- Description of services partners will deliver.
- Tasks and hours per week.
Pros and Cons
-
Benefits:
- Motivate employees.
- Compensate with ownership instead of cash.
- Reward contributions.
-
Drawbacks:
- Complex tax implications.
- Disagreements over valuation.
- Conflict over the percentage share allotted.
Regulations specify the sweat equity valuation method, upper limit at 25% of total shares.
Frequently Asked Questions
Do you pay taxes on sweat equity?
Yes, selling sweat equity shares for profit makes the proceeds taxable.
Can you write off sweat equity?
Sweat equity shares can be subject to complex tax implications, and it’s important to consult with a tax professional regarding potential deductions or write-offs.