New IRS Form Simplifies Section 83(b) Election for Restricted Stock

Understanding the Section 83(b) Election

Employees who receive restricted stock or other property for their services often face a complex tax situation. Typically, income tax is due when the stock vests, meaning when the employee gains full ownership rights. However, a Section 83(b) election allows employees to pay taxes upfront, based on the stock’s value at the time of grant, rather than waiting until vesting.

Who Can File a Section 83(b) Election?

1. Employees: The most common use of the Section 83(b) election is by employees who receive restricted stock or similar equity compensation as part of their employment.
2. Independent Contractors: Contractors and consultants who receive property (such as stock or other equity) for providing services can also make the election if the property is subject to restrictions or a substantial risk of forfeiture.
3. Founders and Entrepreneurs: Startup founders often use the election when receiving restricted stock at the time of forming a company, especially when the initial value of the stock is low. By doing so, they can lock in a low taxable value and benefit from long-term capital gains tax treatment on future appreciation.
4. Business Partners: In some cases, partnerships or LLC members receiving equity interests as compensation for services may make a Section 83(b) election if those interests are subject to vesting or forfeiture provisions.

Requirements for Making a Section 83(b) Election

The election applies when:

• The taxpayer receives property (not cash) for services performed.
• The property is subject to a substantial risk of forfeiture, meaning the taxpayer could lose the property if certain conditions (like continued service or performance goals) are not met. AND
• The election is filed with the IRS within 30 days of receiving the property.

Why Make the Election?

There are two primary benefits to making a Section 83(b) election:

1. Potentially Lower Taxes: If the stock’s value increases between the grant date and the vesting date, making the election can result in lower overall tax liability. This is because the tax is calculated on the initial value, not the potentially higher value at vesting. Example: Imagine an employee receives 1,000 shares of restricted stock with a current market value of $10 per share. If they make a Section 83(b) election, they’ll pay tax on $10,000 of income. If the stock price rises to $50 per share by the time it vests, they won’t owe any additional income tax. Without the election, they would owe tax on $50,000 at vesting.
2. Start the Capital Gains Clock: By making the election, the holding period for capital gains tax purposes begins on the grant date. This can be advantageous if the employee plans to hold the stock for an extended period, as it can lead to lower capital gains taxes down the line.

Strategic Considerations

While the benefits of a Section 83(b) election can be significant, it’s crucial to consider the potential drawbacks:

• Upfront Tax Liability: You’ll need to pay taxes on the stock’s value even though you haven’t fully earned it yet. This can create a financial burden if the stock price remains stagnant or declines.
• Risk of Forfeiture: If you leave the company before the stock vests, you lose the stock and the taxes you paid.
• Alternative Minimum Tax (AMT): The bargain element (difference between the market price and the price you paid) could trigger AMT in the year of election.

When is a Section 83(b) Election Most Attractive?

• Early Stage Companies: If you believe the company has high growth potential, the stock’s value is likely to increase significantly, making the election more beneficial.
• Low Initial Value: If the stock’s current value is low, the upfront tax liability will be minimal, reducing the financial risk.
• Long-Term Outlook: If you plan to stay with the company and hold the stock for a long period, the benefits of starting the capital gains clock early are maximized.

Introducing New IRS Form 15620

Last month, the IRS has introduced Form 15620, a standardized form for making Section 83(b) elections. This form simplifies the process, reducing the risk of errors and making it easier for taxpayers to comply with the rules.

How to File Form 15620

Currently, taxpayers must mail the completed Form 15620 to the IRS office where they file their federal income tax return. However, the IRS is expected to make electronic filing available in the future, further streamlining the process.

Key Takeaway

Form 15620 represents a significant step towards simplifying the Section 83(b) election process. By providing a standardized form, the IRS has made it easier for taxpayers to take advantage of this potentially beneficial tax election. However, careful consideration of your individual circumstances and the potential risks is crucial before making this decision.

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