(From the August 15, 2005 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
Restricted Stock and 83(b) Elections: Issues and Answers
Restricted property grants, specifically restricted stock grants, are likely to become a more popular compensation vehicle because they are subject to the same accounting treatment as options; they are less dilutive than options, and they are exempt from the new rules governing nonqualified deferred compensation under Internal Revenue Code ("IRC") § 409A. However, the administrative requirements and tax implications to executives and the employer are not always obvious. The following outlines some common issues that companies granting restricted stock awards will face.
- When does an employee recognize income from a restricted stock grant?
The excess of the fair market value of the stock (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount (if any) paid for the stock is included in income and reported on a Form W-2 for employees or Form 1099 for independent contractors at the first time the rights of the person having the beneficial interest in the stock are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier.3 Any dividend income received by the employee while the stock is still restricted is treated as compensation to the employee, reported on Form W-2 and 1099 and deductible as a compensation expense to the employer.4 Once the stock is no longer subject to substantial risks of forfeiture, dividends are treated as dividend income and no longer as compensation income.
- When does an employee recognize income from a restricted stock grant for which the employee made an 83(b) election?
An 83(b) election changes the timing of income inclusion and Form W-2 or 1099 reporting to the taxable year in which restricted stock is transferred. If such election is made, there is no additional income recognized when the stock later becomes transferable or no longer subject to a substantial risk of forfeiture. The income included at the time of transfer should be the excess of the fair market value of such stock at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount (if any) paid for it.5 An 83(b) election can be made even if the fair market value of the stock equals the amount paid for the stock and no income is actually recognized.6 If the stock is subsequently forfeited, the employee cannot claim a loss with respect to the amount previously included in income.7 The employee is treated as the owner of the stock when an 83(b) election is made. Therefore, any dividends paid on the stock are dividend income subject to tax at the 15% rate and any subsequent appreciation in the stock is eligible for capital gain treatment.
- When can the employer deduct the compensation expense resulting from the grant of restricted stock?
The employer may take a deduction for restricted stock in the year in which or with which ends the year the employee recognizes income.8 Therefore, when an employee makes an 83(b) election, the employer's deduction is accelerated to the time of transfer. The subsequent appreciation or depreciation of the fair market value of the stock and any dividends paid on the stock after amounts are included in income are not deductible as compensation. The special deduction rule applying to vested property does not apply to restricted stock.9 If the stock is subsequently forfeited, the employer must reverse any deduction claimed with respect to that income.10
- What are the employer's income tax withholding and reporting requirements resulting from the grant of restricted stock?
IRC § 3402(a) requires every employer paying wages to deduct and withhold tax equal to a certain percentage of employee wages. Wages includes "all remuneration... for services performed by an employee for his employer, including the cash value of all remuneration... paid in any medium other than cash... "11 Where wages are paid in the form of property, the employer is still required to deduct and withhold the tax. "If wages are paid in property other than money, the employer should make necessary arrangements to insure that the amount of the tax required to be withheld is available for payment in money."12
- What are the consequences if the employer is not notified of an 83(b) election until the end of the 30 day election period? What are the consequences if the employer receives notification of an 83(b) election after the 30 day election period?
When an 83(b) election is made, withholding is required. However, withholding on the date of transfer is not administratively feasible if employees file their elections after the transfer date. Therefore, in the case where an 83(b) election is made within the 30 day period but not immediately upon transfer, withholding should occur as soon as the employer is notified of the 83(b) election. Withholding should be based on the value of the stock on the date of transfer and not the value of the stock on the date the employer is notified of the 83(b) election.
Special consideration must be given to a situation where the employer is not notified that an 83(b) election has been made within the 30 day election period. Although written notice is required to be given to the employer under the 83(b) regulations, failure to do so is likely considered an administrative error not fatal to the making of the election. Although there are no rulings directly on point, Private Letter Ruling 8429090 is somewhat similar. In this ruling, a copy of the written statement required under the regulations was not filed with the employee's tax return. The ruling states, "we have determined that you fulfilled the procedural requirements for an election under § 83(b) when your statement was received at the Internal Revenue Center... Failure to submit an additional copy of the statement with your... tax return did not affect the validity of the election process." We believe failure to provide the employer with the written statement would be treated similarly and the 83(b) election would still be valid. If the employer is notified of an 83(b) election before the filing of the 4th quarter Form 941, withholding and income recognition should be reflected on the W-2 for the year of the transfer. For example, assume Employee X is granted 10,000 shares restricted stock on December 15, 2005. The value of the stock is $10 on the date of transfer and the employee is required to pay $9 per share. Employee X makes an 83(b) election and notifies Company Y on January 5, 2006 and Company Y has not filed their 4th quarter Form 941 yet. Employee X's 2005 Form W-2 should reflect $10,000 in income (10,000 * ($10 - $9)) and income taxes should be withheld.
- When are employers required to deposit income taxes withheld due to restricted stock transfers?
Employers that had total tax liabilities in the calendar year preceding the previous year of more than $50,000 must generally follow the semiweekly deposit schedule. This requires that taxes accumulated on payments made on Saturday, Sunday, Monday and/or Tuesday are required by the following Friday. Taxes accumulated on payments made on Wednesday, Thursday and/or Friday are required to be deposited by the following Wednesday. However, if a tax liability accumulates to $100,000 or more on any day during a deposit period, employers must deposit the tax by the next banking day.13 Although the tax withholding obligation belongs to the employer and not the employee, late withholding and deposit due to the employer's lack of awareness of an election should not result in penalties for the employer. For example, the IRC § 6656(a) penalty for failure to make a timely deposit of income taxes withholding would not apply if such taxes were not withheld.14 Similarly, the penalty for failure to pay taxes under IRC § 6651 should not apply. In this situation, there is a valid argument that the employer was not willfully negligent but rather could not withhold timely because they were unaware that such withholding was required.
Please contact your Deloitte advisor if you have questions or need additional information.
3 IRC § 83(a).
4 Treas. Reg. § 1.83-1(a)(2).
5 IRC § 83(a) and (b).
6 Treas. Reg. § 1.83-2(a).
7 IRC § 83(b)(1).
8 IRC § 83(h) and Treas. Reg. § 1.83-6(a)(1).
9 Treas. Reg. § 1.83-6(a)(3).
10 Treas. Reg. § 1.83-6(c).
11 IRC § 3401(a).
12 Treas. Reg. § 31.3402(a)-1(c).
|The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.
If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.
Copyright 2005, Deloitte.
BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.