Originally published on Forbes.com Nov 7th, 2014
What’s the point of being a high tech guy if you have to pay ordinary income tax on most of the consideration when your ship comes in? I wonder if that was Brian Brinkley’s thinking. When Google acquired Zave Networks Mr. Brinkley was entitled to 3% of the $93 million in consideration. So when over $1.8 million of the amount he received showed up on his W-2, he and his tax preparer tried to address the issue with Form 4852, which among other things can be used to indicate disagreement with Form W-2. This story is interesting enough to bring out my inner investigative reporter, but I decided to stuff him back in the box and just be a tax blogger. So the somewhat muddled story I’m telling is what the Tax Court ended up believing. Mr. Brinkley and his advisers may well have a different view of the matter.
About Zave Networks And Google
I still haven’t figured out exactly what it was that Zave was doing, but I here is the general gist of it from Bloomberg::
The company’s platform provides a redemption solution to marketers, retailers, financial institutions, digital media companies, social networks, and mobile wallet providers to connect offers distributed in digital media with in store redemption. Its platform enables consumers to use various digital discounts, offers, and values to buy the products they want right at the same stores where they shop every day.
It does seem like the type of thing that Google would be interested in. As it turned out, it didn’t work out all that well. It was announced in June, that Googlewas abandoning the program.
….sources say the program did not expand as quickly as Google had hoped, in part due to some retailers’ uneasiness with giving Google access to information about their best customers.
Their motto is “Don’t be evil” and people still don’t trust them. Go figure. According to its 10-K Google started this year with $110 billion in assets, so a one hundred million acquisition gone awry will probably not kill them.
None of that has anything to do with Mr. Brinkley’s tax problems, but I don’t think the story is complete without it.
Getting To 3%
Mr. Brinkley was one of the founders of Zave. After working as an independent contractor, he became a salaried employee in 2010 – Chief Technology Officer. He had a 9.8% stake and had made an 83(b) election with respect to any stock that was not fully vested. As successive rounds of capital were raised, his interest was diluted. He indicated that he would not be willing to stay on if his interest dropped below 3%. In deference to this concern he was issued restricted stock. Nonetheless, by the fall of 2011 his 1,340,000 shares (200,000 of which were not yet vested) represented less than 1% of the company’s outstanding shares.
As the Google deal was looming, Mr. Brinkley brought the 3% commitment up again. To address his concern Zave provided him with a letter agreement. Under the section labelled “Compensation”, the company agreed to pay him the difference between 3.1/93 of cash paid by Google and the amount that he received for his stock. Mr. Brinkley did not sign the agreement. He gave it to his accountant to review. His accountant showed it to the tax attorneys that he was working for. They were concerned that the compensation label spelled ordinary income.
Mr. Brinkley engaged the attorneys to negotiate a better agreement for him. He indicated that he owned equity in the company but did not disclose that it was valued at $800,000. For whatever it is worth, the Tax Court seems to indicate that nondisclosure is a big deal.
A New Agreement
The negotiations yielded a new agreement.
During negotiations with petitioner’s tax advisers, Zave sent a modified letter agreement dated August 1, 2011, the terms of which petitioner did not accept. Zave then sent to petitioner a final letter agreement dated August 27, 2011 (letter agreement II). Under the heading “Consideration”, letter agreement II provided that, following the merger, Zave would pay petitioner as consideration $3,100,000 of the $93,000,000 purchase price offered by Google in exchange for “(i) all of *** shares, warrants and options of *** and (ii) *** execution of a Key Employee Offer Letter and Proprietary Information and Inventions Assignment Agreement with Google as required in the Merger Agreement”. Letter agreement II also provided that petitioner would “not be entitled to the Consideration, except for any amount you would be entitled to receive in exchange for your shares *** in the absence of this Agreement, if you do not comply with the terms of the Merger Agreement”.
Mr. Brinkley reviewed a copy of the merger agreement, but did not share it with his advisers. There was schedule that indicated he was a deferred compensation recipient, but he was not provided with that. Again without consulting with his advisers, he signed a consent to the merger agreement. He did not sign a consent of the deferred compensation recipients that was given to other service providers. That strikes me as a big deal, but it did not seem to make much of an impression on the Tax Court.
Finally he signed an agreement with Google agreeing to become a Goggle employee but also turning over proprietary information and an inventions assignment.
About That W-2
The Tax Court seems to indicate that Mr. Brinkley’s response to finding out that most of the consideration was showing up on his W-2 was not spirited enough.
When petitioner became aware that Zave, through the merger terms and through its payroll company, treated most of his “consideration” as deferred compensation, he did not attempt to cure Zave’s alleged breach either by requiring Zave to reissue a corrected Form W-2 or by pursuing legal recourse against Zave in accordance with the “Governing of Law and Forum” section of letter agreement II.
Instead, petitioner elected only to take “amenable” action to attempt to correct the situation. This action amounted to a single demand letter, allegedly being sent to Zave, which threatened the filing of a legal suit and the challenging of Zave’s reporting through an adverse position to be taken on petitioner’s tax return. In the letter, De Luna referenced the outdated letter agreement dated August 1, 2011, because petitioner had not disclosed that he had already executed letter agreement II. The demand letter received no response from Zave.
Well you know, he stood to receive a $2.5 million bonus if he lasted three years with Google (Based on his linkedin profile he missed by five months for whatever that is worth). You can really understand why he might have wanted to minimize boat rocking over tax technicalities.
It Is What It Is
The Tax Court is not buying Mr. Brinkley’s recharacterization of the proceeds. Mr. Brinkley argued that there were two requirements for the amount paid over and above the stock. One was that he go to work for Google and the other was that he surrender other rights. His argument, which sounds pretty reasonable to me was that the Google job offer was so good, that he didn’t need no stinking signing bonus, so all the consideration is attributable to the surrendered rights.
In the end, it appears that petitioner made a decision to receive his merger-based income and his position at Google without causing a stir about receiving deferred compensation. He then used his 2011 income tax return in an attempt to “regain” his desired preferential tax treatment that he had earlier abandoned by not challenging Zave. We cannot presume that in an agreement to pay petitioner for completing two requirements Zave actually intended for the entire amount to be paid with respect to only one of those requirements. The preponderance of the evidence, without regard to burden of proof, is that petitioner received the value of his stock and compensation for service previously rendered or to be rendered in the future. Accordingly, respondent’s determination on this issue is sustained.
And A Penalty?
The IRS almost always asserts the accuracy penalty, but sometimes the Tax Court will not sustain it. In this case the Court did.
Petitioner argues that he relied on professional tax advisers, namely his return preparer and tax attorneys, to ensure that the capital gain tax treatment he desired would be achieved. While his effort to achieve his desired tax treatment is evident, that is not the same thing as making an effort to assess the proper tax liability. Petitioner chose to keep from his advisers essential facts, such as the amount of stock he owned and the stock’s determined value in comparison to the amount he was receiving, and essential documents, such as the executed consent of the shareholders and the initial merger agreement. It is not reasonable for petitioner to rely on his tax advisers where he had knowingly obscured the complete picture of his tax situation from them.
Additionally, the return preparer Richter—who prepared the Form 4852—did not testify. We have no evidence as to the competence and expertise of the preparer, and it appears that the preparer relied solely on petitioner’s representations.
The Tax Court was also seemed quite upset about an odd item.
Petitioner reported estimated tax payments of $465,782 and withholding credits of $58,560—even though he had made no estimated tax payments for 2011 and the total amount of Federal income tax withheld from petitioner for 2011 was $524,341.25. Petitioner chose to report estimated tax payments of $465,782 as a way to reclassify the amount that he had determined as having been wrongfully withheld from the $1,879,779.03 shown on his 2011 Form W-2,Wage and Tax Statement, as stock compensation pay by Zave’s payroll company.
Moreover, misrepresenting information on Federal tax forms, as petitioner did when he reported withheld taxes as estimated tax payments, does not show good-faith effort to reach the proper tax liability.
I thought that “misrepresenting” was pretty harsh. Ironically, calling the withholding estimated payments pretty much guaranteed that his return would get attention. There are a lot of camels that the IRS will swallow, but one thing that they tend to be really on top of is whether the estimated payments you are claiming are accurate.
Monday Morning Quarterbacking
Clearly Mr. Brinkley would have helped himself with the penalties if he had given all documents to his advisers. Should he have made more of a fuss about the W-2? There you get into business judgement. You wouldn’t want tax issues to screw up the deal. If I could have changed one thing, I would have separated the transfer of rights from the employment letter. I hope Mr. Brinkley appeals this decision. It may be right on the capital gain issue, although there is still an argument there. And I think it is wrong on the penalty.
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