U.S. Federal Income Tax Consequences of the Purchase of Restricted Stock or Restricted Units; Section 83(b) Election
The following summarizes certain U.S. federal income tax considerations applicable to a taxpayer’s purchase or other receipt of shares of capital stock in a corporation or units in a limited liability company (the “Equity”) that will be subject to vesting restrictions and possible forfeiture upon the occurrence of certain events.
After a taxpayer’s receipt of Equity, the taxpayer must decide whether or not to make an election under Section 83(b) of the Internal Revenue Code of 1986, as amended (the “Code”). We recommend consulting with a tax advisor before making this decision. The election must be filed within 30 days of the receipt of the Equity. No extensions are possible under current law.
Making the 83(b) Election
In general, by making an election under Section 83(b) of the Code (a “Section 83(b) Election”), the taxpayer chooses to be treated as the owner of the Equity for U.S. federal income tax purposes as of the time of receipt (the “transfer” of the Equity) rather than at some later date when unrestricted ownership of the Equity “vests” or is no longer subject to forfeiture.
If the taxpayer makes a Section 83(b) Election, it must include as compensation income for the year of transfer the difference, if any, between the fair market value of the Equity at the time of transfer and the price the taxpayer paid for the Equity (including the fair market value of any property transferred to the company in exchange for the Equity). If the price paid is equal to the full fair market value of the Equity, the taxpayer should incur no U.S. federal income tax liability as a result of the purchase. The value that the taxpayer ascribes to the Equity, however, is not binding on the Internal Revenue Service and may be challenged.
Potential Advantages of Making (and Disadvantages of Not Making) an 83(b) Election
|There will be no U.S. federal income tax consequences at the time when the Equity vests resulting in deferral.|
|If the taxpayer subsequently sells or otherwise disposes of the Equity in a taxable transaction, any appreciation in the value of the Equity since the taxpayer acquired it generally will be taxed as capital gain, rather than ordinary income.|
|Because the fair market value of the Equity may be higher at the time of vesting than at the time of transfer and because of the application of ordinary rates, the taxpayer’s income tax liability may be greater if it is determined at the time of vesting rather than the time of transfer. Additional social security and employment taxes may also be incurred at the time of vesting.|
|The holding period for the Equity for purposes of determining whether income from the sale qualifies as long-term capital gain or for the exclusion from gain available for “qualified small business stock” will not begin until the Equity has vested if not election is made|
|If the Company is not publicly traded at the time of vesting, the Equity will be illiquid and (except in certain limited circumstances) may not be able to be sold to pay the U.S. federal income tax.|
Potential Disadvantages of Making (and Advantages of Not Making) an 83(b) Election
|There is no deferral and tax must be paid in the year the Equity is received. If the taxpayer later forfeits the Equity, they will not be allowed a deduction for any amount reported as income at the time of transfer or for any additional taxes paid as a result of making the election.|
|If the taxpayer purchased the Equity at a price less than fair market value and if for any reason ownership of any Equity never vests, the taxpayer will not be taxed on the receipt of the unvested Equity|
|A Section 83(b) Election generally cannot be revoked.|
Instructions for Making a Section 83(b) Election
If the taxpayer decides to make the election, the taxpayer must complete an “Election to Include in Gross Income in Year of Transfer of Property Pursuant to Section 83(b) of the Internal Revenue Code” form, sign and date it, and file it with the Internal Revenue Service Office where the taxpayer files its annual tax returns when no payment is included with such returns. More information on Section 83(b) is available in IRS Publication Number 525 which is available on the Internal Revenue Service’s website. The taxpayer should consult a tax advisor to obtain and prepare the form. In addition, the taxpayer should make two copies of the form and (i) place one copy with the records of the Company and (ii) retain the other copy and attach it to the taxpayer’s U.S. federal income tax return for the applicable taxable year.