Q: What is a Section 83(b) Election, and what are the benefits of making it?
A: A common strategy in implementing a business succession plan involves granting restricted stock or equity in the business to key employees. Stock is considered “restricted” where the recipient of such stock is not treated as its owner for corporate governance or income tax purposes until certain, specified conditions are met and the restrictions fall away, an occurrence called “vesting.”
There are no federal income tax consequences to the recipient of restricted stock when granted. Instead, the recipient of restricted stock recognizes income because of the grant of restricted stock when it vests. Upon vesting, the recipient of the stock must recognize ordinary income in an amount equal to the then fair market value of the vested stock. Similarly, the recipient’s holding period for long-term capital gain treatment with respect to the restricted stock begins upon vesting.
Section 83(b) of the Internal Revenue Code permits a recipient of restricted stock to elect (the “83(b) Election”) to accelerate the recognition of ordinary income and the commencement of the recipient’s holding period for long-term capital gain treatment to the date on which the restricted stock is granted. In order to make the 83(b) Election, the recipient must submit a letter to the Internal Revenue Service indicating the recipient’s intention to make the Election no later than 30 days following the date on which the restricted stock was granted. The letter must include a statement of the then fair market value of the restricted stock and enclose a payment of the estimated corresponding income tax.
Making the 83(b) Election can provide significant tax benefits so long as the conditions for vesting are ultimately met and the value of the stock increases from the time of grant to the time of vesting. Under these conditions, the recipient benefits by making a larger portion of the value of the stock available for long-term capital gain treatment than is available if no 83(b) Election is made.
The 83(b) Election presents significant risks that must be considered. A taxpayer has no remedy in the event that he or she makes an 83(b) Election with respect to restricted stock that does not ultimately vest or that decreases in value. There is no opportunity to claim a loss in either case.
Know the Law is a bi-weekly column sponsored by McLane Middleton. Questions and ideas for future columns should be emailed to [email protected]. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.