The tax consequences of a transfer of property in connection with the performance of services is covered by I.R.C. §83. In general terms, I.R.C. §83(a) provides that the fair market value of the property transferred over the amount of any payment for the property is included in the service provider’s income in the year the property is received. However, if the property is subject to a substantial risk of forfeiture or otherwise not transferable, then the income does not have to be included until the forfeiture lapses or the property becomes transferable.
For example, if Employee X received property (typically an ownership interest in her employer) that was worth $100,000, and X paid nothing for the property but the property would be forfeited if X was no longer employed during the first five years after receipt, X would not have to report any income until the year during which the aforementioned five-year period ended. X would pick all the income up as ordinary income and then, if the stock appreciated in the future, any eventual gain on a sale would be capital gains. X’s basis would be the amount of ordinary income picked by the end of year five.
As an alternative, X can elect to pick the income up in the year of receipt of the stock. The advantage of doing this is that while X will report ordinary income five years earlier, any appreciation after receipt of the property is all capital gains. In order to achieve this result, X has to file what is known as an I.R.C. §83(b) election within 30 days of receipt of the property. For example, if X received stock in her employer that is worth $1,000 at the time of receipt, she can elect to report the $1,000 as ordinary income in that year. If at the end of five years it is now worth $100,000, X does not have to pick any income up in year five because she already reported the income in year one. Additionally, when X eventually sells the stock, any gain in excess of $1,000 is treated as capital gains.
Prior to the issuance of these final regulations, the taxpayer had to file an I.R.C. §83(b) within thirty days after receipt of the property at the Internal Revenue Service Center where the taxpayer filed his or her federal income tax return had to attach a copy of the election to his or her Form 1040 that covered the period of the year of receipt. Under the final regulations, the taxpayer is no longer required to submit an election with the taxpayer’s return. These regulations apply to property transferred on or after January 1, 2016. However, for transfers on or after January 1, 2015 and prior to January 1, 2016, the preamble to the proposed regulations provides that the taxpayer may rely on the guidance in the proposed regulations. Note that the election still has to be filed within 30 days of the receipt of the property at the Internal Revenue Service Center where the taxpayer files her return.
Michael A. Kulzer is the founding shareholder of the firm and earned his J.D. degree at the Rutgers University School of Law, where he was awarded the Prentice Hall Award for outstanding performance in the area of taxation. He earned his LL.M. in Taxation at New York University. Mr. Kulzer’s particular areas of expertise include estate planning, corporate taxation and business planning.