2.17 Restricted Stock
If in return for performing services you buy or receive company stock (or other property) subject to restrictions, special tax rules apply. Unless you make the Section 83(b) election discussed below, you do not have to pay tax on the stock until the first year in which it is substantially vested, which is the year that the stock either becomes transferable or is not subject to a substantial risk of forfeiture. A risk of forfeiture exists where your rights are conditioned upon the future performance of substantial services. In the year the property becomes substantially vested, you must report as compensation (wages) the difference between the amount, if any, that you paid for the stock and its value at the time the risk of forfeiture is removed. The valuation at the time the forfeiture restrictions lapse is not reduced because of restrictions imposed on the right to sell the property. However, restrictions that will never lapse do affect valuation.
SEC restrictions on insider trading are considered a substantial risk of forfeiture, so that there is no tax on the receipt of stock subject to such restrictions. However, the SEC permits insiders to immediately resell stock acquired through exercise of an option granted at least six months earlier. As the stock acquired through such options is not subject to SEC restrictions, the executive is subject to immediate tax upon exercise of an option held for at least six months.
If the stock is subject to a restriction on transfer to comply with SEC pooling-of-interests accounting rules, the stock is considered to be subject to a substantial restriction.
Caution
Non-employees.
The tax rules for restricted property are not limited to employees. They also apply to independent contractors who are compensated for services with restricted stock or other property.
Sale of property that is not substantially vested.
If you sell restricted property in an arm’s-length transaction before it has become substantially vested and you did not make the Section 83(b) election discussed below, gain on the sale (amount realized minus what you paid) must be reported as compensation income for the year of the sale. If the sale is to a related person or is otherwise not at arm’s length, compensation must be reported not only for the year of sale but also for the year the original property becomes substantially vested, as if you still held it. In the later year, the compensation income equals the fair market value of the stock minus the total of the amount you paid for it and the compensation reported on the earlier sale.
Election to include value of restricted stock in income when received (Section 83(b) election).
Although restricted stock is generally not taxable until the year in which it is substantially vested, you may elect to be taxed in the year you receive it on the unrestricted value (as of the date the stock is received), less any payment you made. This election, called a Section 83(b) election, must be made by filing a signed statement with the IRS (at the Service Center where you file your return) no later than 30 days after the date the stock is transferred to you. Also give a copy of the statement to the employer or other party for whom you provided the services. The statement must specify that you are making the election under Section 83 (b) and include the following: your name, address, Social Security number, the year for which you are making the election, a description of the stock and the restrictions on the stock, the date you received the stock, the fair market value of the stock at receipt (ignoring restrictions unless they never lapse), your cost, if any, for the stock, and a statement that you have provided a copy of the statement to your employer or other party for whom the services were provided.
Planning Reminder
If you make the election, you are treated as an investor and later appreciation in value is not taxed as pay when your rights to the stock become vested. When you sell the stock, your basis for figuring capital gain or loss is your cost basis increased by the amount of income you reported as pay under the Section 83 (b) election. If you forfeit the stock after the election is made, a capital loss (5.4) is allowed for your cost minus any amount realized on the forfeiture. The election may not be revoked without the consent of the IRS.