# At formation, in exchange for stock, X contributes cash, Y contributes only “services provided” (sweat equity). What's a smart way to do it?

Setup: X has cash, Y has an idea, experience and contacts and wants to work on this idea full-time. X wants to create a corporation with Y and contribute \$100,000 for 50% of its equity. Everything happens in the US. Y wants to get 50% of stock of the newly formed company, but not to be taxed on the \$50,000 "gain". In other words, can Y prevent IRS from making the case that he just got valueable stock without paying for it in cash or property?

Option 1: Y receives 50% of stock "for services provided" (and contributes no cash) and X gets remaining 50% of stock in exchange for \$100k in cash (assume at the same time, at formation). Does Y immediately incur taxable gain of \$50k?

Option 2: Same as before, but Y receives 50% of stock in consideration for "for services provided, valued at \$50,000". Same question.

Option 3: Say there is 1 million shares authorized. Y gets 500k shares on day 1 at \$0.0001 per share, paying \$50 in cash. Since the company has no assets and is essentially worthless, Y records fair value of the stock as \$50, and hence has no taxable gain. On day 2, X gets his 500k shares in exchange for \$100,000 in cash, i.e. for \$0.2 each, and records fair value of the stock acquired as \$50,000 (50% of the company whose total assets are \$100,000 in cash). Same question about taxation of Y's stock.

Options 1B, 2B, 3B: same as before, but instead of getting the stock as an individual, Y forms ABC, which is a single-member LLC. Say a month later ABC creates the corporation with X, as per respective option defined above. Does this LLC layer and the one-month gap between formation change tax implications?

Options 1C, 2C, 3C: same as 1B-3B, but instead of a corporation, ABC creates a 50/50 JV with X. Again X contributes only cash, and ABC contributes only "services". JV's total assets will be \$100k, and ABC (and hence Y) will now have a gain. Is this a capital gain? When will Y get a tax bill for it?

Any other option(s) that would allow Y to optimize his taxes? If instead of "services" Y contributes "intellectual property" (with plausible description of say his business concept), valued at \$50,000, does that change anything?

Thank you, really appreciate any advice here.

• "Does Y immediately incur taxable gain of \$50k?" Only when you sell the shares, I think. – RonJohn Sep 29 '19 at 15:39
• Tim, did you include the common approach "X makes a loan to the new company" – Fattie Sep 30 '19 at 11:16