Today many employees, as part of their compensation and benefits package, receive stock-based payment from their employer. The tax consequences of such payment can be complicated — subject to employment, capital gains, ordinary income, and other taxes. Though, if you receive restricted stock awards, Section 83(b) election might give you a tax-saving opportunity.
Convert ordinary income to long-term capital gains
Restricted stock is stock your employer grants you subject to a substantial risk of forfeiture. Until the stock isn’t subject to that risk, income recognition is typically delayed (that is, it’s vested) or you sell it.
During that time, you pay taxes on the stock’s fair market value (FMV) at your ordinary income rate. The FMV will be considered Federal Insurance Contributions Act (FICA) income, so it also could initiate or increase your exposure to the additional 0.9% Medicare tax.
However, you can instead make a Sec. 83(b) election recognize ordinary income when you receive the stock. This election, which you must make within 30 days after getting the stock, allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until you sell the stock.
The Sec. 83(b) election can be helpful if the income at the grant date is negligible or the stock is likely to appreciate significantly. It might be a good time to recognize such income with ordinary income rates now meager under the TCJA.
Weigh the potential disadvantages
There are some inherent disadvantages, however:
- You need to prepay tax in the current year, but that could also push you into an increase of the additional 0.9% Medicare tax or trigger or higher income tax bracket. However, if your company is in the earlier stages of development, the income recognized may be relatively small.
- If you eventually forfeit the stock or sell it at a decreased value, any taxes you pay because of the election cannot be refunded. You would have a capital loss in those situations.
- Any gain you get when you sell the shares will be included in net investment income and could trigger or increase your liability for the 3.8% net investment income tax.
As you can see, tax planning for restricted stock is intricate. If you have recently received limited stock or expect to be awarded such stock this year, contact us. We can help you know if the Sec. 83(b) election applies to your specific situation.
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Ben R Shull CPA LLC provides clients with tax, transaction, and advisory services. The insights and quality services we deliver help lead our clients through the next generation of changes, and accelerate growth while reducing risk. CPA Katy, TX.