Avoiding Unnecessary Taxes With Slicing Pie
There is more than one way to make a Pie from a legal standpoint, the big issues relate to how shares are actually issued in a way to avoid unnecessary taxes. All equity-split models create more or less tax exposure depending on how the deal is executed. In some cases, the final split can be adjusted upon termination of the Pie even if shares have already been issued.
For instance, a team may have issued each founder a fixed number of shares at the outset of the venture and would like to make an adjustment to reflect the fair Slicing Pie split. Let’s say Joe and Tom had 500 shares each when they created a 50/50 split. At breakeven, Slicing Pie indicates a fair split of 60/40 based on the actual contributions. Issuing 250 new shares to Joe would mean he has 750 shares and Tom has 500. The new split is now 60/40 because there are now 1,250 outstanding shares. However, the new shares might trigger an income tax for Joe even though he was not paid in cash. Especially if the Pie bakes as the result of a Series A investment which would set a price for the shares that would apply to the new shares.
To avoid the income tax, it would be smarter to buy shares back from Tom at a pre-set value. The stock-purchase agreement could specify a buy back price of a nominal value upon termination of the fund (like a penny). Thus, no new shares would be issued and no tax would apply. Joe would keep his 500 shares, but Joe would sell back 166.67 shares for $1.68 leaving him with 233 shares. Now the outstanding total is 833 and the partners still have a 60/40 split.
The math can get a little tricky when there are multiple contributors who own shares, which is why you can use the Slicing Pie recalibration tool as explained in the video below:
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Another common scenario would be using Slicing Pie as a vesting tool instead of the traditional unfair time-based vesting. In this scenario, each participant would receive a fixed chunk of restricted shares when they join the team. Let’s say 1,000 shares each. So, Joe and Tom each have 1,000 shares and file an 83(b) election with the IRS. When the Pie terminates, each person would simply vest a number of shares so that it would match the fair Slicing Pie split. If the fair split was 60/40, all of Joe’s 1,000 shares would vest and 666.7 of Tom’s would vest bringing them to the right split.
Both scenarios can use the recalibration calculator and both would avoid unnecessary taxes. Of course, you need to speak with a licensed tax advisor (which I am not) to see which strategy works for you, but there is no reason why Slicing Pie should cause a company or person to pay any more in tax than other equity split models.