Often an employer will issue stock to an employee in exchange for the employee’s services and the shares vest over time, provided the employee remains employed with the issuer. Generally, the value of stock that the employer transfers to the employee as compensation for the employee’s services is includible in the employee’s gross income when it is not subject to, or can be transferred free of, a substantial risk of forfeiture. In other words, the value of stock that the employer transfers to the employee as compensation for the employee’s services is includible in the employee’s gross income either in the first tax year in which it is not subject to a substantial risk of forfeiture or when the employee can transfer the stock free of the substantial forfeiture risk, whichever occurs earlier.
Assume an employee will be entitled to 100 shares of stock if he completes two years of employment following the date on which his restricted stock is granted. Under the tax rules, the employee can either defer the income attributable to the grant of this restricted stock until the employee’s rights in the stock become vested, or elect – by making and IRC § 83(b) election – to recognize income at the time the stock is granted.
The amount of the income recognized as a result of the election is based on the fair market value (FMV) of the shares on the date of grant. The advantage of accelerating income through an IRC § 83(b) election is that employee will not be taxed on any future appreciation in the stock until the employee sells the stock, at which time the employee will be taxed at capital gain rates. If the employee does not make the IRC § 83(b) election, the employee will be treated as receiving taxable income (at ordinary income tax rates) equal to the stock’s FMV on the date the restrictions lapse. Many employers and employees overlook the importance of making a timely IRC 83(b) election. It must be done in 30 days of the grant of restricted stock. Failure to make this tax election can be expensive.
