Receiving restricted stock awards? Consider the Sec. 83(b) election.
Many employers provide stock awards as part of the compensation and benefit package for their employees. The tax consequences of such compensation can be complex — subject to ordinary-income, capital gains, employment and other taxes. But if you receive restricted stock awards, you might have a tax-saving opportunity in the form of the Section 83(b) election.
Convert ordinary income to long-term capital gains by electing Sec. 83(b)
Restricted stock is stock subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk (that is, it’s vested) or you sell it. At that time, you will pay taxes on the stock’s fair market value at your ordinary-income rate and it will be considered FICA income. Thus when the stock is no longer subject to risk or you sell it, your exposure to the additional 0.9 percent Medicare tax could be triggered or increased.
A possible more favorable option may be to make a Sec. 83(b) election to recognize ordinary income within 30 days of receiving the stock. This election allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold.
The Sec. 83(b) election can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly. With ordinary-income rates now especially low under the Tax Cuts and Jobs Act, the timing may be right to recognize such income.
Weigh the pros and cons
Consider some potential disadvantages, however:
- You must prepay tax in the current year — which also could push you into a higher income tax bracket or trigger or increase the additional 0.9 percent Medicare tax. But if your company is in the earlier stages of development, the income recognized may be relatively small.
- Any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or sell it at a decreased value. However, you’d have a capital loss in those situations.
- When you sell the shares, any gain will be included in net investment income and could trigger or increase your liability for the 3.8 percent net investment income tax.
Don’t go it alone
As you can see, tax planning for restricted stock is complicated. And the Tax Cuts and Jobs Act may raise additional questions about your tax liability. The summer is the perfect time to meet with your accountant or tax advisor because it allows time for you to make any necessary changes to position yourself for the most favorable tax outcome. For sound tax planning advice contact Nick Leacoma, CPA, Ciuni & Panichi, Inc. Senior Manager at 216-831-7171 or by email here.
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