IRC Section 83 discusses the treatment regarding property that was received in connection with performance of services. The Tax Cuts and Jobs Act added an election to defer the recognition of taxable income with respect to specific items under Section 83(i). Even though the election is limited, it does produce significant benefits. Some common examples are giving stock to independent contractors or giving an interest of the business to an accountant or attorney. Sometimes, someone will provide a service and the receiving individual is not able to pay for it, so they give the individual an interest in stock.
Under 83(a), the general rule is whenever an individual gives an interest in the business to another individual, the interest becomes taxable immediately unless it is restricted. The person giving the interest will recognize it as a deduction, while the person receiving the interest will recognize it as ordinary income. Since this is treated as taxable ordinary income, the interest is subject to ordinary withholding taxes and FICA, or self-employment tax if the individual is an independent contractor. While it is restricted, any increase in value will be taxed at ordinary rates when it finally becomes vested.
Section 83(b), states that if it is restricted, the person may elect to have it taxed immediately and is taxed at the ordinary tax rate. After the initial tax is paid at ordinary rates, future increases in value will be taxed at a capital rate. This rate is usually lower than the ordinary tax rate. This election is eligible for partners and independent contractors. However, if the owner elects 83(b), they must notify the IRS of the election. This election applies to interest that was not vested. Not vested means that the individual will not get the interest until a requirement has been met. The individual will receive the interest but may have to give it back. An example of this is when someone will be entitled to a total of 100 shares at 20 shares per year, only if that individual works for five years. If they do not work for five years, they will not get that interest or be expected to give it back.
Section 83(i) is the new election. With this election, the income tax related to the interest is deferred up to five years and then is taxed at the ordinary rate. Any gain while it is restricted is taxed at capital gain rates, after the restriction period ends. This election is eligible for corporations with employees and applies to stock instead of interest. This election is usually made when an individual had the choice to elect 83(b) but did not have the funds to pay the tax upfront. If an individual decides to elect 83(i), they must notify their employers. Corporations are required to notify the employee of their status regarding this. Corporations have a little more power dealing with 83(i) by deciding whether they want employees to elect 83(i). For example, if corporations do not put the shares of stock into an escrow account, employees cannot elect 83(i). Therefore, the stock for those options must be put into an escrow account in order to elect 83(i). However, corporations must inform employees if an escrow account is available.
An advantage of election 83(i) is that it is revocable. If an individual files with the IRS within 30 days of receipt of the property and informs them that it is restricted, then those tax implications get deferred until the individual does have access or at least some later period. Tax is paid based on fair market value on the day it is received. This is common for employees. This election mostly benefits startup ventures that could not elect 83(b) because they did not have the cash upfront to pay for it.
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By Brittany Burke