Consider the tax implications of being awarded restricted stock

A Section 83(b) election holds some advantages


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In recent years, restricted stock has become a popular form of incentive compensation for executives and other key employees. But if you’re awarded restricted stock, it’s important to understand the tax implications.

Restricted stock is, by definition, stock that has been granted to an executive that is nontransferable and subject to forfeiture under certain conditions, such as termination of employment or failure to meet either corporate or personal performance benchmarks. Restricted stock also generally becomes available to the recipient under a graded vesting schedule that lasts for several years.

Restricted stock and restricted stock units are taxed differently than other kinds of stock options, such as statutory or non-statutory employee stock purchase plans. Those plans generally have tax consequences at the date of exercise or sale, whereas restricted stock usually becomes taxable upon the completion of the vesting schedule.

Restricted stock income recognition is normally deferred until the stock is no longer subject to that risk or you sell it. You then pay taxes based on the stock’s fair market value when the restriction lapses and at your ordinary-income rate.

But you can instead make a Section 83(b) election to recognize income when you receive the stock rather than later on when the stock vests.

Making the Section 83(b) election allows you to report as ordinary income in the year the stock is granted the fair market value of stock as of the grant date. The election, which you must make within 30 days after receiving the stock, can be very beneficial if the fair market value of the stock at the grant date is negligible or the stock is likely to appreciate significantly before income would otherwise be recognized.

Why? Because the election allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.

Capital gains treatment begins at the time of grant and not at vesting. This type of election can be especially useful when longer periods of time exist between when shares are granted and when they vest.

Election irrevocable

But there are some potentially significant disadvantages of a Section 83(b) election:

 • You must prepay tax in the current year. If a company is in the earlier stages of development, this may be a small liability.

 • There is a substantial risk of forfeiture associated with the Section 83(b) election that goes above and beyond the standard forfeiture risks inherent in all restricted stock plans. Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or its value decreases. The election is irrevocable once made. If you did make the election and the value of the stock decreased, you would still have to report as ordinary income the fair market value of the stock on the grant date. But at least you would have a capital loss when you forfeited or sold the stock.

If you’re awarded restricted stock before the end of 2012, and it’s looking like your tax rate will go up in the future, the benefits of a Section 83(b) election may be more likely to outweigh the potential disadvantages.

Jared R. Yeaton, manager of tax services for Nathan Wechsler & Co., Concord, can be reached at jyeaton@nathanwechsler.com

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