7.1.3: Use Of Preferred Stock To Shelter The Disproportionately Low Price To The Sweat Equity

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Abstract

Again to state a fundamental proposition, there is no available cash in an early stage financing with which to pay federal and/or state income taxes. Consequently, anything that smacks of a taxable event is verboten. The norm, however, is that the founders will obtain their interests in the new entity in consideration of past services and/or the capitalized value of the founders' talents and services to be rendered; the promoters, if different from the founders, are obtaining stock for their organizational efforts. The omnipresent danger is that the IRS will successfully assert the position that all or a portion of the stock issued to the founders has been, for tax purposes, issued for services and a current tax is payable. Since that position reflects the economic reality, it is dangerous.