Businesses wishing to accelerate their ability to deduct the value of nonqualified stock or other property transferred to an employee or contractor as compensation for services and employees and independent contractors anticipating the need to make a Section 83(b) election to minimize income tax on property to be received as compensation for service subject to a substantial risk of forfeiture which the recipient expects to grow in value may find sample language contained in Revenue Procedure 2012-29 (Revenue Procedure) helpful. While this new tool may faciliate the cost of preparing an election, executives and others receiving property as compensation and the businesses providing that compensation should exercise care to properly understand and manage responsibilities and requirements impacting these and other compensation arrangements under Section 89 and a growing list of increasingly complicated and diverse laws, regulations and other requirements.
The Revenue Procedure contains sample language that the Internal Revenue Service (IRS) says employees and independent contractors may (but are not required) to use to make the “83(b) election” that Section 83(b) of the Internal Revenue Code (Code) requires the property recipient to make to accelerate income recognition as well as provides examples of the income tax consequences of making such an election.
Section 83(b) Election As Tax Planning Tool
Code Section 83 plays a key rule in determining when:
- When the value of property received by an employee or other service provider as compensation for the performance of services becomes taxable to the recipient;
- The timing of the valuation of the property; and
- The timing of the employing businesses’ deduction of this property.
Treasury Regulation Section 1.83-3(f) specifies that property is transferred in connection with the performance of services if it is transferred to an employee or independent contractor (or beneficiary thereof) in recognition of the performance of services, or refraining from performance of services. Where Section 83 applies, the transfer of property is subject to Section 83 whether such transfer is in respect of past, present, or future services.
Code Section 83(a) generally provides that if, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of the fair market value of the property (determined without regard to any restriction other than a restriction which by its terms will never lapse) as of the first time that the transferee’s rights in the property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over the amount (if any) paid for the property is included in the service provider’s gross income for the taxable year which includes such time.
Where the property transferred as compensation is expected to increase in value from the time of the grant until transfer restrictions or risks of forfeiture lapse, the delay in income recognition dictated by Section 83(a) generally has the effect of increasing the income tax that the recipient will pay on the property.
Assuming that the value of the property when the property is granted is adequately ascertainable, however, Section 83(b) and Section 1.83-2(a) permit the service provider to elect to include in gross income the excess (if any) of the fair market value of the property at the time of transfer over the amount (if any) paid for the property, as compensation for services by making a timely Section 83(b) election.
Under Section 83(b)(2), an election made under Section 83(b) is only effective to accelerate the recognition of taxable income from the transfer of property for services if made in accordance with the regulations and filed with the IRS no later than 30 days after the date that the property is transferred to the service provider.
Treasury Regulation Section 1.83-2(c) provides for a service provider to make a Section 83(b) election be made under Section 83(b) is made by filing a copy of a written statement that meets the requirements of the Regulation with the IRS office with which the person who performed the service files his return and submitting a copy of that statement with his income tax return for the taxable year in which such property was transferred. Section 1.83-2(d) requires that the person who performed the services also submit a copy of the Section 83(b) election to the person for whom the services were performed.
While the Regulations dictate the required content of the Section 83(b) election, until now the IRS had not dictated or otherwise provided model language for use in making this election.
The Revenue Procedure provides model language to aid service providers who receive substantially nonvested property in connection with the performance of services and wish to file an election under Section 83(b).
While the model language should make the completion and filing of a desired Section 83(b) election easier for those wishing to accelerate income recognition from property received as compensation for services, employees and other service providers receiving property as compensation and their employers are cautioned to consult with qualified tax counsel or advisor about the applicability and implications of making a Section 83(b) election. Section 83 conditions the availability of the option to make a Section 83(b) election on the property having a “readily ascertainable fair market value” when transferred and timely election. In the case of stock options and certain other property, valuation issues may disqualify the transfer for coverage by a Section 83(b) election.
Beyond the restrictions on the use of the Section 83(b) election, parties considering making the election are cautioned to fully understand the consequences of making the election. Under certain circumstances, making an election to minimize future taxes can have unexpected consequences. For instance, a taxpayer that makes the election should be prepared to pay taxes on the property in the year received even though transfer or forfeiture restrictions on the property may prevent the taxpayer from selling or using the property currently.
Because the election is irrevocable hardships also can happen if the property decreases rather than increases in value after the date of transfer. Once made, Section 83(b) elections generally are irrevocable without the approval of the IRS, which is difficult to secure. Consequently, a service provider that makes a Section 83(b) election also runs the risk that he may pay greater taxes by making the election if the property subsequently declines in value. Of course where the employer conditions the grant of property on the making of the Section 83(b) election, the recipient employee or contractor may not be able to avoid this risk. At minimum, however, the service provider should be prepared for this possibility and have arrangements in place to meet the resulting tax obligations when they arise.
Ensure Old Compensation Experience Not Rendered Obsolete By New Rules
Because of the lengthy tenure of Section 83 of the Code, many businesses and their leaders often feel comfortable that past experience makes the need to consult tax and other experts about the design and implementation of property based or other compensation arrangements. While this may be the case in some instances, changing rules make it advisable that parties participating in these arrangements check their understanding to avoid stepping into unanticipated traps.
The longstanding provisions of Section 83 are part of a growing list of tax, securities and other rules that executives, board members, and other service providers and the businesses that receive their services may be required to successfully negotiate when seeking to use stock or other property as compensation for services.
Ongoing changes in the law and regulations concerning executive and other compensation transactions and evolving lender, shareholder and contractual relationships makes it advisable that parties participating in these and other compensation arrangements seek the advice of competent legal and accounting service providers with experience with these concerns.
Beyond Section 83, executive and other compensation arrangements increasingly also be impacted by new Code provisions like the complicated rules of Code Section 409A, shareholder approval, securities and other disclosure requirements, conflict of interest and other board and organizational governance, and a host of other requirements that may have ramifications well in excess of the tax consequences that were historically the primary concern in the design of these arrangements in past decades. For certain publically traded businesses, proper valuation, reporting and disclosure and in some instances, even shareholder approval of certain compensation arrangements may be critical. Likewise, IRS Form 990 and other emerging tax and other rules increasingly require that nonprofit health care, education and other non-profit organizsations be prepared to defend the design, valuation, and reporting of executive and certain other compensation arrangements . Even in closely held start ups and certain other organizations, founders and others often unintentionally incur significant liability by offering employees who do not qualify as exempt under the Fair Labor Standards Act or as accredited investors under securities law private placement exemptions or making other expensive compensation design missteps.. Amid these and other growing responsibilities, getting executive and other compensation arrangements right plays a critical role to the success of a business and the management of its liability.
For Help With Risk Management, Compliance & Other Management Concerns
If you need assistance in auditing or assessing, updating or defending your organization’s compensation, employee benefits and other workforce compliance, risk management or other internal controls practices or actions, please contact the author of this update, attorney Cynthia Marcotte Stamer here or at (469)767-8872.
Board Certified in Labor & Employment Law by the Texas Board of Legal Specialization, management attorney and consultant Ms. Stamer is nationally and internationally recognized for more than 24 years of work helping employers and other management; employee benefit plans and their sponsors, administrators, fiduciaries; employee leasing, recruiting, staffing and other professional employment organizations; and others design, administer and defend innovative workforce, compensation, employee benefit and management policies and practices. Her experience includes extensive work helping employers implement, audit, manage and defend union-management relations, wage and hour, discrimination and other labor and employment laws, privacy and data security, internal investigation and discipline and other workforce and internal controls policies, procedures and actions.
Immediate past Chair of the American Bar Association (ABA) RPTE Employee Benefits & Other Compensation Committee and current Co-Chair of its Welfare Benefits Committee, Vice Chair of the ABA TIPS Employee Benefits Committee, a Council Representative on the ABA Joint Committee on Employee Benefits, Government Affairs Committee Legislative Chair for the Dallas Human Resources Management Association, and past Chair of the ABA Health Law Section Managed Care & Insurance Interest Group, and former Employee Benefits & Insurance Professor for the University of Dallas Graduate School of Management, Ms. Stamer works, publishes and speaks extensively on management, reengineering, investigations, human resources and workforce, employee benefits, compensation, internal controls and risk management, federal sentencing guideline and other enforcement resolution actions, and related matters. Her experience includes extensive work advising businesses and executives on Code Section 83, 409A, 280G, and other tax, employment, securities and relates concerns relating to nonqualified and qualified deferred compensation, incentive stock option, severance, and other compensation and benefits arrangements. She also is recognized for her publications, industry leadership, workshops and presentations on these and other human resources concerns and regularly speaks and conducts training on these matters. Her insights on these and other matters appear in the Bureau of National Affairs, Spencer Publications, the Wall Street Journal, the Dallas Business Journal, the Houston Business Journal, and many other national and local publications. For additional information about Ms. Stamer and her experience or to access other publications by Ms. Stamer see here or contact Ms. Stamer directly.
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