Providing stock or other equity capital interests in the employer’s capital is a common element of executive compensation. Most often, the shares are issued at a discount from fair market value or at no cost for the employee. In these cases, the bargain element is subject to federal taxation as ordinary compensation.
If the shares are subject to the risk of having to be returned (i.e., a “substantial risk of forfeiture”), this income does not have to be recognized until that risk lapses (when the shares totally vest). The tradeoff in deferring the income until the lapse of the risk of forfeiture, however, is the possibility that the value will have grown during this interim period, and the ordinary income component could be significantly higher than when the compensatory shares were originally granted.
To avoid this outcome, the Internal Revenue Code allows for an election known as the “Section 83(b) election” that permits the taxpayer to recognize the income component in the year the shares are granted. Any future appreciation after this year is subject to capital gains tax rates.
Historically, the taxpayer receiving the shares was required to file a valid Section 83(b) election with the Internal Revenue Service within 30 days of the original date of transfer. In addition, the taxpayer had to attach a copy of this valid election to his or her Form 1040, U.S. Individual Income Tax Return for the year of the stock or equity transfer, pursuant to Treasury Regulations under Section 1.83-2(c). A failure to attach the election to the return has often been challenged by the Internal Revenue Service as invalidating the election all together and forfeiting the tax benefits anticipated by the taxpayer in using this strategy.
The Internal Revenue Service recently issued proposed regulations eliminating the requirement that taxpayers submit a copy of a Section 83(b) election with their tax returns for the year the property was transferred. This election must still be submitted to the Internal Revenue Service within 30 days of the date of transfer. These proposed changes allow taxpayers to choose to report income in the year non-vested property from the performance of services is received, rather than the year when the property substantially vests. Eliminating the need to attach a copy of the election to the taxpayer’s return will promote e-filing of tax returns.
The proposed regulations will apply to property transfers on or after January 1, 2016, but may be relied upon for property transferred on or after January 1, 2015. Thus, the effect of the new rules may be considered with 2015 transfers.
Questions regarding the new proposed regulations can be submitted to Bob Grossman and Don Johnston.
