An individual who receives property in exchange for the performance of services generally would report the fair market value of that property received as ordinary income, subjecting the individual imposition of the ordinary income tax rate on the fair market value of the property received. Internal Revenue Code § 83(a) states where such property is “subject to a substantial risk of forfeiture” it is excluded from ordinary income until such time that the property is substantially vested. At such time when the property does become vested, the fair market value of the property at that point in time is taxed as ordinary income rates.
When a taxpayer receives non-vested equity compensation, they can make an IRC § 83(b) election to have the property included in the taxpayer’s income as ordinary income based on the fair market value of the property on the date the IRC § 83(b) election is made. This IRC § 83(b) election may result in favorable tax consequences as the property is taxed as ordinary income on the date the election is made and any further appreciation on the equity compensation would be taxed at the lower capital gains rate rather than at the ordinary income tax rate once the property finally vests. The IRC § 83(b) election does come with inherent risks. For example, in instances where the property is forfeited, no deduction is allowed for the amount that was previously included in ordinary income and in instances where the value of the property depreciates only a capital loss may be taken, despite the fact that ordinary income tax rates were initially imposed on the acquisition of the property.
Under the new proposed regulations, the requirements to make an § 83(b) election are to: (1) file a statement with the IRS Service Center where the taxpayer would file his or her individual tax return within 30 days of receiving the stock or other property subject to § 83(a); and (2) provide a copy of the election to their employer/service recipient.
In the past, the IRS required you to file your § 83(b) election along with your annual individual tax return, however, under new proposed regulations (Federal Register, Vol. 80, No. 137, REG-135524-14) issued in July 2015, an § 83(b) election may now be filed separately from an individual’s tax return. The proposed change applies to property transferred after January 1, 2016, however taxpayers may rely on the proposed regulations for property transferred on or after January 1, 2015.
These proposed regulations provide a significant benefit to nonresident taxpayers, namely it allows a non-U.S. tax resident who receives property subject to § 83(a) taxation to make a § 83(b) election at the time he or she receives the non-vested property subject to a substantial risk of forfeiture. Ultimately, this would allow the fair market value of the property received to escape U.S. taxation as that income would be foreign source income earned by a nonresident at the time of election even if the non-U.S. tax resident becomes a U.S. tax resident by the time the property vests.