In response to the COVID-19 pandemic, the IRS recently issued Notice 2020-23 to extend the deadline to July 15, 2020, for any Internal Revenue Code Section 83(b) election that would otherwise have been due on or after April 1, 2020, and before July 15, 2020.
General tax treatment under Section 83 of the Internal Revenue Code
Generally, when an employee, consultant or other service provider receives unvested property (such as restricted stock award or restricted stock received upon early exercising a stock option) in connection with the performance of services, no federal income tax is due on the fair market value of the property received until the property becomes either freely transferable by the service provider or vested, which often occurs several years later when the value of the property has appreciated. If the fair market value of property received in connection with the performance of services appreciates significantly between the date the property is transferred to the service provider and the date the property becomes either freely transferable by the service provider or vested, the increased value results in higher taxable compensation income for the service provider.
How 83(b) elections work
Under an election made pursuant to Section 83(b) of the Internal Revenue Code (an 83(b) election), a service provider may choose to accelerate the taxation of compensation income associated with the receipt of unvested property into the year in which the property is transferred to the service provider. If an 83(b) election is properly made, the service provider pays ordinary income tax on the excess of the property's fair market value, measured on the date the property is transferred, over the amount (if any) the service provider paid for the property. If and when the property later vests or becomes transferable, no additional income tax is due. When the property is sold, the service provider pays capital gains tax on the amount the property has appreciated since the date it was transferred to the service provider. Currently, the top federal ordinary income tax rate is 37%, and the top federal capital gains tax rate is 20% for property held in excess of one year.
Regular and extended deadlines for 83(b) elections
Under ordinary circumstances, to make an 83(b) election, the service provider must file a notice with the IRS no later than 30 days after receiving the transferred property and there are no exemptions, extensions or grace periods available. Failure to timely file an 83(b) election results in the taxpayer paying ordinary income tax rates based on the property's fair market value as of the date the property vests or becomes transferable, less the amount (if any) the taxpayer paid for the property. However, as a result of the COVID-19 pandemic, the IRS has extended the deadline until July 15, 2020, for 83(b) elections that would otherwise be due on or after April 1, 2020, and before July 15, 2020.
83(b) election risks
Despite its benefits, making an 83(b) election is not without risk. If a service provider chooses to accelerate the income tax payment to the date the property is transferred by making an 83(b) election and later forfeits the property, the taxpayer is not entitled to offset his or her ordinary income in the year of forfeiture by the value of the property forfeited. Taxpayers should consult with their tax advisors when determining whether an 83(b) election is the best decision based on their individual circumstances.
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