Section 83(b) Election: Standardization Realized
What is it? What’s new? And how do you make it work for you?
By Mitchell Kopelman, partner-in-charge of Tax, and Shay Eubanks, senior manager
Through the decades, there has been growing uncertainty around how to properly make the 83(b) election for restricted stock, and as those uncertainties grew, the cries to the IRS for a clear revenue procedure grew as well. Individuals and companies demanded an easier, standardized way to make the election, and on June 26, 2012, the cries were answered as the IRS released a standard template for this specific election.
Though the Section 83(b) election has been available to employees receiving stock options since 1969, the manner in which you elect it has never been quite certain. Knowing that there has been confusion in the past, the IRS issued Revenue Procedure 2012-29 on June 26, 2012 to provide a model form for the election that enables employees and independent contractors to make an election under the IRC Section 83(b) with a higher degree of clarity.
What is an IRC Section 83(b) election?
The IRC Section 83(b) election is a popular tax-saving election for employees with startups and smaller companies that offer restricted property as an incentive to retain top talent, rather than increased salary; however, companies of all sizes and across all industries can utilize this type of incentive and the election. The 83(b) election allows individuals receiving restricted property to change the tax treatment of the restricted property received for providing services. Generally, restricted property is shares in a corporation, but it can be interests in non-corporate entities, such as partnerships or limited liability companies.
Section 83(b) allows employees immediately to include the fair market value of the restricted property received in their taxable income. A couple of things automatically take place upon making this election. First, the holding period of the restricted property begins immediately upon transfer. This is important for purposes of determining capital gains treatment once the stocks vest. Second, applicable payroll withholding tax obligations are triggered. With respect to the payroll tax withholdings, the employer includes the value of the restricted property in the employee’s taxable wages. This increase in withholding taxes serves to reduce the employee’s net pay. Situations could arise where the value of the property is high enough that the increase in withholding taxes could be in excess of the employee’s remaining net pay. In such situations, the employee would have to fund the additional payroll tax withholding. The key point is the employee must inform their employer that an election has been made so the employer will know to adjust the payroll accordingly.
The primary benefit of making the 83(b) election is to reduce the amount of ordinary income that must be recognized when the property vests. An employee who made a Section 83(b) election is not subject to income tax when the restrictions lapse (i.e., the property vests), despite the fair market value of the property at the time of the restriction. Taxes will be incurred only upon the ultimate sale of the property. Future increases or decreases in the property’s fair market value will be capital gains or losses, depending on whether or not the property was a capital asset.
While computing the gain or loss from a subsequent sale or exchange of property for which a Section 83(b) election was made, the regulations provide that the basis of such property shall be the amount paid for the property, if any, increased by the income triggered by the Section 83(b) election.
Can there be negative consequences associated with the 83(b) election?
The answer is yes; traps exist for the unwary. For example, a person that makes an election and then later forfeits their property cannot recover the taxes previously paid. The second trap is the reality of market conditions. If the value of the property decreases in between the time of the election and the time the property vests, or restrictions lapse, the taxpayer runs the risk of paying more tax than was necessary.
Under the new model, how do I make the election?
An election under Section 83(b) is made by filing a copy of a written statement with the IRS Center where the employee files their tax return. This must be done no later than 30 days after the property is transferred to the employee. This can now be done using the IRS’s recently issued model form which provides taxpayers a higher level of certainty for making the election.
Financial statement treatment
Depending upon the facts and circumstances, the treatment for financial statement purposes can differ. Aprio can assist with determining the appropriate treatment for your unique situation.
For more information about making a Section 83(b) election, contact Shay Eubanks, senior manager, at firstname.lastname@example.org.