To Be or Not to Be, or Why a W-2 or 1099-B?

Paying employee shareholders in a merger can get a little confusing. In most transactions, employee shareholders (and vested options holders), share in the proceeds of the merger and escrow. When distributions are made at closing (or later on due to escrow releases or earn-outs), some employees receive their payments through the escrow/paying agent while others receive payments from the buyer, and others receive payments from both. To add to the confusion, some employees get 1099-Bs while others receive W-2s even after they leave the selling or buying company. Why?

It all depends on how the employee received their shares. If an employee is a shareholder who either purchased their shares or received their shares and executed an 83b election, then any merger-related payout is considered an “investment.” The employee receives payments through the paying/escrow agent and has proceeds reported on 1099-B tax forms.

However, if an employee received restricted stock and did not make an 83b election, or exercised vested options (or net-exercised) at closing, then any receipt of funds is usually considered “compensation.” Like other employee compensation, it is paid via payroll and reported on W-2s, even if the individual is no longer an employee when the payment is made. Because of this distinction, shareholder reps and company buyers need to be aware of the proper tax treatment for each shareholder participating in escrows (and other deferred payments of merger consideration) and ensure that funds are routed in the correct manner and reported on the appropriate tax forms.