What is Code Sec. 83(b)?
Code section 83 discusses the tax consequences of property transfers in connection with services performed where the transferee’s rights to the property are subject to a substantial risk of forfeiture. The 83(b) election is an election that allows you to opt to include the excess of the fair market value over the cost of the restricted property as income in the year the property is received. At the time of the 83(b) election the excess of the fair market value over the cost is taxed at ordinary income tax rates.
What is Meant by “Substantial Risk of Forfeiture”?
To qualify under section 83(b) the property transferred must be subject to restrictions or more specifically “substantial risk of forfeiture”. Property is subject to substantial risk of forfeiture if the rights of the property that are transferred are conditioned upon the future performance by any person, or the possibility of forfeiture is substantial, if conditions in relation to the purpose of the transfer are not met.
As an example, a substantial risk of forfeiture will exist where stock is transferred to an employee prior to a public offering and the rights of those stocks are transferable or vested only upon successful completion of certain conditions by the employee. A second example is where an employee receives property from an employer subject to a requirement that the property be returned if total earnings of the employer do not increase. A substantial risk of forfeiture does not exist based on the risk of the value of the property declining during a certain period of time or a non-lapse restriction, standing by itself.
Why should I Consider Making an 83(b) election?
If the 83(b) election is made in a subsequent event when the rights of the property become transferable or vested, the taxpayer will not be required to include the excess of the fair market value over the cost in their income. When the taxpayer sells or disposes of the property and there is an appreciation in value since the date of transfer, then the income to be recognized will be taxed at favorable capital gain tax rates. The holding period of the property begins on the date of the transfer and if the property is held for more than one year the taxpayer would receive favorable long-term capital gain tax rates.
The 83(b) election is quite common and often favorable when involving early stage companies at lower valuation points or mature companies that anticipate a strong increase in valuation. However, careful consideration needs to be taken when the company does not have a low market value. In the event that a taxpayer liquidates his/her position and the value of the company has decreased since the 83(b) election was made, then the taxpayer will have overpaid his or her income tax liability. Keep in mind that the election is not revocable and the taxpayer cannot claim a refund for those taxes that may have been overpaid.
When is the Election Due and What Information is Required?
The 83(b) election must be made within 30 days of the transfer of property to the transferee. An election is made by sending a letter to the IRS which provides information regarding the taxpayer and a statement formally making the election. In addition the election provides a description of the property that has been transferred in exchange for services along with a description of the nature of the restrictions on the property. A copy of the election will be kept by the IRS, the transferor, and the transferee. Once the 83(b) election is made it is not revocable.
Please do not hesitate to contact us should you have any questions about receiving stock for services or how the 83(b) election may impact your situation.