What type of stock options qualify for 83(b) election
Vesting requirements can be met by the passage of time, or by company or individual performance. Restricted stock awards and control and restricted stock are two entirely different concepts. Restricted stock awards relate to equity compensation, and control and restricted stock to securities law. Control and restricted stock involves unregistered shares of stock that are restricted by SEC Rule Under normal federal income tax rules, an employee receiving Restricted Stock Awards is not taxed at the time of the grant assuming no election under section 83 b has been made, as discussed below.
Instead, the employee is taxed at vesting, when the restrictions lapse. The amount of income subject to tax is the difference between the fair market value of the grant at the time of vesting minus the amount paid for the grant, if any. Upon a later sale of the shares, assuming the employee holds the shares as a capital asset, the employee would recognize capital gain income or loss; whether such capital gain would be short- or long-term depends on the time between the beginning of the holding period at vesting and the date of the subsequent sale.
Consult your tax adviser regarding the income tax consequences to you. Section 83 b of the Internal Revenue Code permits the taxpayer to change the tax treatment of their Restricted Stock Awards. Employees choosing to make the Special Tax 83 b election are electing to include the fair market value of the stock at the time of the grant minus the amount paid for the shares if any as part of their income without regard to the restrictions.
They will be subject to required tax withholding at the time the Restricted Stock Award is received. Also with a Special Tax 83 b election, employees will not be subject to income tax when the shares vest regardless of the fair market value at the time of vesting , and they will not be subject to further tax until the shares are sold.
Subsequent gains or losses of the stock would be capital gains or losses assuming the stock is held as a capital asset. However, if an employee were to leave the company prior to vesting, he would not be entitled to any refund of taxes previously paid or a tax loss with respect to the stock forfeited.
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A Special Tax 83 b election must be filed in writing with Internal Revenue Service IRS no later than 30 days after the date of the grant, and you must send a copy to your company. There are several potential advantages with a Special Tax 83 b election: Establish your cost basis now.
By paying tax on your grant now, rather than when the shares vest, the current stock price will be established as the cost basis for the shares granted. When the shares do vest, no tax will be due until the shares are sold, regardless of how much the shares may have changed in value. Control the timing of future income recognition. Gain or loss would be recognized only when the stock is actually sold and would not be triggered by the lapse of restrictions at vesting.
Capital gains treatment. Assuming the stock is held as a capital asset, future gains or losses would be taxed only as capital gains, and therefore would be subject to favorable capital gains tax rates. Whether to make a Special Tax 83 b election is an important tax and financial decision, and employees are urged to consult their tax advisers.
There are several potential disadvantages to consider: Falling share prices.
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If the stock price declined by the vesting date, there is a risk that you would pay more tax based on the fair market value on the grant date than you would be obligated to pay at vesting based on the fair market value of the stock at vesting. Timing of tax payment. Since taxes are due when the award is granted, you must use other funds to pay the tax withholding obligation. Under normal tax treatment, you do not owe taxes until the grant vests, and you could potentially use some of the shares vesting to cover your tax withholding obligation.
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Risk of forfeiture. If you forfeit your restricted stock award e. Additionally, you would not be able to receive any refunds on the tax paid on your restricted stock award.
What steps do I need to take to make a Special Tax 83 b Election? You must also send a copy of the Special Tax 83 b election to your employer, and you must attach a copy of the form when you file your yearly income tax return. This page will open in a popup window. Assuming you did not make a Special Tax 83 b election, you can either net shares, sell shares or pay cash depending on the rules of your plan. Under the netting of shares option, you are instructing your employer to withhold enough shares to pay the tax withholding due at vesting.
You will be left with the number of shares that vested less the number of shares withheld to cover your tax withholding obligation. If you elect to sell shares, you will need to provide Fidelity with a one-time authorization which gives Fidelity the authority to sell a portion of your vesting shares to cover your tax withholding obligation.
Once accepted, the authorization is good for all subsequent sell shares elections. You will be left with the number of shares that vested less the number of shares sold to cover your tax withholding obligation, plus any residual cash from the sale of shares. If you decide to pay cash, you will need to have enough cash in your Fidelity Account SM on the day of vesting to cover your tax withholding obligation. Once you vest Fidelity will debit the amount necessary to cover your tax withholding obligation from your account and forward it to your company for reporting and remitting it to the appropriate regulatory agencies.
What is a Section 83(b) Election and Why Should You File One?
In certain situations, where a taxpayer receives substantially nonvested NQSOs with a readily ascertainable FMV at grant, there can exist an opportunity to make a Sec. A Sec. This is an alternative to the standard NQSO treatment that includes the bargain element in income at the post-vesting exercise date of the options. Under the election, any appreciation of the stock, beyond the FMV at the time of the election, will be taxed at preferential capital gains tax rates rather than ordinary rates. In some cases, this could result in a large income tax savings.
It is important to note that the election must be made no later than 30 days after the property transfer, and if the stock received is later forfeited, no deduction or refund of tax previously paid is allowed. Careful analysis and research should be done before making the election. A unique opportunity associated with NQSOs is the ability to gift the options.
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Unlike Sec. Additionally, Sec. The bargain element income from the exercise will be recognized by the individual who performed the services to earn the options. The donee will not be subject to income tax on this amount. The tax paid is not a taxable gift to the donee, as it is a personal liability of the donor.
The issuing company's plan must allow for gifting of such options. ISOs are similar to NQSOs in that they represent a right to purchase shares at a specific price within a certain period. For the option holder to reap these benefits, the options must qualify as ISOs under Sec. The following list illustrates some of the requirements that must be met for an option to be an ISO:. This list is not all - inclusive , but it provides a general idea of the types of rules that must be complied with for an option to qualify as an ISO.
Qualifying disposition: If options that meet the requirements to be ISOs are disposed of in a qualifying disposition, the owner of the ISOs will receive the following tax treatment upon exercise of the options and the subsequent sale of the stock:. Disqualifying disposition: If the ISO stock is disposed of in a disqualifying disposition i. Thus, the income attributable to the exercise of the option the FMV of the stock at the time it is substantially vested less the exercise price is treated by the option holder as ordinary compensation income for regular tax purposes in the tax year the disqualifying disposition occurs.
However, if the disqualifying disposition of the stock is a sale or exchange for a price less than the price of the stock at exercise, the amount that is includible as compensation attributable to the exercise of the option is limited to the excess if any of the amount realized on the sale or exchange over the adjusted basis of the stock. If the disqualifying disposition occurs in the same year as the exercise, the tax treatment is similar to that for an NQSO, with the bargain element in the stock at the time of exercise being ordinary income for the option holder in the year of exercise for both regular tax and AMT purposes, so that no AMT adjustment is necessary in that year.
If the stock is disposed of in a disqualifying disposition for an amount greater than the FMV of the stock at exercise, the character of the amount of gain is determined under the Sec. AMT considerations and planning opportunities. Between the limitation and removal of typical itemized deductions that have caused taxpayers to be subject to the AMT, plus an increase in the AMT exemption amount, an environment has been created where many individuals who have historically been subject to the AMT will no longer find themselves in that situation.
Individuals with high ordinary income, such as wages, could be even further immunized from the AMT regime. On the surface, a taxpayer's being subject to the AMT in the year of exercise seemingly thwarts the strategy behind owning ISOs. This situation somewhat hinders the option holder's enjoyment of the coveted ISO benefits.
It is important to remember that all is not necessarily lost if clients find themselves subject to the AMT during the year of exercise due to the AMT credit, which is explored further below. The following are some planning options associated with ISOs:. Exercising and immediately selling will trigger a disqualifying disposition.
Similar to the strategy discussed in the NQSO section, this strategy may appeal to those clients looking to limit their cash outlay or exposure to a concentrated position in company stock. The options are exercised and the shares are sold more than two years after the grant date and more than one year after exercise. The tax results of a qualifying disposition are described above. As noted, in this scenario, appreciation in the value of the stock above the exercise price will be taxed at long - term capital gains rates. Intentional disqualifyingdisposition. Prior to the dot - com bubble of the late s, many individuals in the tech industry exercised highly valued ISOs, incurring a large AMT liability on top of the price paid to exercise options.
After the market crash and subsequent rapid devaluation of their position, some were left holding stock worth significantly less than the price they paid to acquire it and were unable to pay the AMT incurred due to the exercise of the ISOs. A method to potentially avoid a disaster like this would be to exercise early in the year, or some other time that is deemed advantageous, and track the stock value throughout the year.
If the value greatly depreciates, the stock can be sold before year end. This would intentionally trigger a disqualifying disposition, thus avoiding the positive AMT adjustment and any accompanying AMT tax liability. This is a mix of the exercise - and - sell and the exercise - and - hold strategies. Like the strategy discussed in the NQSO planning section, this can be used to improve cash flow during the exercise event. The immediate sale of the shares to cover the AMT is a disqualifying disposition. The remaining shares received can be held for future appreciation and, if the holding period requirements are met, favorable qualifying disposition treatment.
If an individual already owns shares of company stock and wants to limit the cash outlay on the exercise of ISOs, a swap could be of value. The existing shares will be exchanged with the issuing company for the new ISO shares. It is important to note that the swap itself is tax - free , but not necessarily the exercise, as this could generate an AMT liability. Consideration should be given for special situations, such as if the shares being swapped in are ISO shares themselves. The company's stock plan must allow for swapping. When taxpayers find themselves subject to the AMT as a result of the exercise of ISOs, all or part of the AMT paid will generate a credit to be used against regular tax in future years.
Often, the principal event that will unlock use of this credit is when the ISO shares are ultimately sold. The regular tax stock basis is lower due to the absence of any income inclusion at exercise. This difference in basis for regular tax versus AMT purposes generally causes the regular - tax income to be higher than AMTI as a result of the sale. While paying AMT upfront may appear to be a loss, in many cases it will be a "timing" issue that balances out in the future.
At times for CPAs, it is easy to focus narrowly on obtaining the best tax result possible. It is important to take a step back and remember that the most favorable tax result is not always the best overall financial result for the client. Any stock option planning should be done as part of a comprehensive financial plan. It is crucial for CPAs to be proactive in gathering information from clients to provide timely and prudent advice.