Filing an 83(b) Election Just Became a Little Easier

July 21, 2015

On July 17, 2015, the IRS proposed changes to the 83(b) regulations. These changes should make it slightly easier to comply with the requirements for filing an 83(b) election.
Key points:

•     Old requirements: The 83(b) election had to be filed with the IRS within 30 days of grant AND with the taxpayer’s income tax return.
•     Proposed requirement: The 83(b) election only has to be filed with the IRS within 30 days of grant.
•     Reason: online tax return filing is becoming more popular. However, 83(b) elections are problematic with online filing.
•     Effective date: January 1, 2016 but taxpayers can rely on the changes as of January 1, 2015.

Background:
Section 83(a) of the Internal Revenue Code (Code) provides that property transferred to an employee is included in their gross income for the taxable year as of the first time that the employee’s rights in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier. With restricted stock, there is often a vesting requirement that results in a substantial risk of forfeiture until the end of the vesting period. The end of the vesting period results in the stock being taxable to the employee at FMV and treated as W-2 income.

Section 83(b) and §1.83-2(a) permit the employee to elect to include in gross income, as compensation for services, the excess (if any) of the fair market value of the property at the time of transfer over the amount (if any) paid for the property. This election allows employees to establish a basis upon grand of restricted stock, so that future gains will be capital in nature. There are risks to this election that should be considered before making it. One of the primary risks is that if the employee takes the value of restricted stock into income in the year of grant, but does not meet the vesting period, the employee will have income, but no asset and no way to take a loss.

Under section 83(b)(2), an election made under section 83(b) must be made in accordance with the regulations thereunder and must be filed with the IRS no later than 30 days after the date on which the property is transferred. Under §1.83-2(c), an election under section 83(b) is made by filing a copy of a written statement with the IRS office with which the person who performed the services files his or her return. In addition, the person who performed the services is required to submit a copy of such statement with his or her income tax return for the taxable year in which such property was transferred. Section 1.83-2(d) requires that the person who performed the services also submit a copy of the section 83(b) election to the person for whom the services were performed.

Example:

Assume Paul Inc. has a restricted stock plan. Stock granted to employees of Paul under this plan vest after a 5-year period. Kristi, a new executive, was granted restricted stock worth $10,000 on January 5, 2015.Kristi believes that the value of the stock will increase significantly over the next five years. Kristi can make an 83(b) election and include the $10,000 into her current income.

Assuming the stock is worth $25,000 at the end of five years, Kristi will not recognize any gain upon vesting of the stock. When the stock is sold, Kristi will have capital gain equal to the difference between the sale proceeds and the value of the stock at the time of the grant ($10,000). Kristi has effectively converted ordinary income into capital gain income.

If Kristi had not filed the election, then she would include the $25,000 in taxable income as ordinary income for the year in which the vesting was complete. Any future appreciation above $25,000 would be treated as a capital gain. Assume the same facts as above, including the fact that Kristi made the 83(b) election, except that Kristi quit two years after the grant. In this case, at the date of 83(b) election, Kristi would have ordinary income of $10,000 but at termination would not have a loss since she did not pay for the stock.