By Robert Q. Johnson, Business Taxation

New IRS Rules Streamline 83(b) Election Filings

On July 26, the IRS released final regulations regarding the requirements for taxpayers making 83(b) elections. The new regulations streamline the process by allowing taxpayers to make the election during the year and still file their income tax return electronically. Previously, taxpayers had to file the election with the IRS on paper within 30 days of receiving the property subject to the 83(b) election, then again on paper when they filed their income tax return for the year. Under the new rules, only the first filing is required, allowing taxpayers to file their annual returns electronically.

Code section 83(a) governs the tax treatment when taxpayers (usually employees) receive property as compensation for services. In those cases, the fair market value of the property (often company stock) is included in the taxpayers income during the year in which the property is no longer subject to a substantial risk of forfeiture (referred to as vesting). Section 83(b), however, lets the taxpayer choose to be taxed in the year in which the property is received. Although this generates tax liability up front, it is beneficial in that it allows any tax on the appreciation of the property between the time of receipt and the time of vesting to be deferred until the taxpayer sells the property. Additionally, when the taxpayer eventually sells the property, any gain is taxed at the lower capital gains rates rather than as ordinary income.

An example helps illustrate this principle. On January 1, 2016, an employee is given 500 shares of stock of the company for which he works. At the time, each share is worth $20, for a total of $10,000 worth of stock. However, if the employee quits before January 1, 2019, he will forfeit all 500 shares of stock and receive nothing in return. The employee continues working until January 1, 2019, at which point each share of stock is worth $350, for a total of $17,500. Under the default rules of section 83(a), the employee would not be taxed in 2016 (when he is given the shares), but would instead have $17,500 of compensation in 2019 (when the shares vest, or are no longer at risk of forfeiture). All $17,500 would be wages, meaning the employee is taxed in 2019 at his ordinary income rate and must pay payroll taxes on all $17,500. If the employee then sold the stock in 2022 for $20,000, he would have $2,500 of long-term capital gains in 2022. On the other hand, if the employee filed an 83(b) election by January 31, 2016, he would have $10,000 in compensation in 2016, subject to ordinary income tax rates and payroll taxes. Then when the stock vested in 2019, the employee would not have any additional income. When he sold it in 2022 for $20,000, he would report $10,000 in long-term capital gains. The downside to making an 83(b) election under these circumstances is that the employee must pay taxes in 2016 on stock that he could lose or that may decrease in value by 2019.

Before the recent regulations, taxpayers making 83(b) elections had to file two written statements of the election. The first was required to be filed within 30 days after receiving the property, and an additional one was required to be filed with the taxpayers income tax return for the year of the election. The second filing caused an inconvenience because electronic filing software often does not allow for the election to be filed with the tax return, meaning that taxpayers wishing to make an 83(b) election had to file their returns by paper. To facilitate e-filing, the final regulations eliminate the requirement that a second notice of the election be filed along with the income tax return. (Even under the new rules, however, the first filing must still be made on paper.)

Although the final regulations apply only to elections made on or after January 1, 2016, they also indicate that taxpayers can rely on the proposed regulations for all 83(b) elections made on or after January 1, 2015. Since the final regulations are identical to the proposed regulations, this effectively means that a second filing is not required for any election made since the beginning of 2015.

* A special thanks to Alan Carpenter for assisting with the research for and preparation of this alert.

The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.