In Order to Eliminate Obstacles to E-Filing of Tax Returns, the Section 83(b) Election Would No Longer Be Included with the Annual Tax Return

DISCUSSION

On July 17, 2015, the IRS proposed regulations (the “Proposed Regulations”) that would eliminate the requirement that a copy of an election under Section 83(b)1 be filed with the taxpayer’s annual tax return for the year in which election is made.

Special rules apply to taxpayers who are compensated with property that is subject to a substantial risk of forfeiture (so-called “unvested property”, such as restricted stock that will be forfeited if the taxpayer voluntarily terminates employment before the restrictions lapse). As a general matter, such unvested property is not included in ordinary income until the property is no longer subject to a substantial risk of forfeiture (i.e., until the property “vests”). In the year the property vests, the taxpayer must recognize compensation income equal to the excess of the fair market value of the property at the time of vesting over the amount (if any) the taxpayer paid for the property and the employer is required to withhold income and employment taxes on the value of that excess amount at the time of vesting.

A taxpayer can elect under Section 83(b), however, to instead recognize ordinary income in the year the property is granted, in an amount equal to the excess of the fair market value of the property at the time such property is granted to the taxpayer over the amount (if any) the taxpayer paid for the property (a “Section 83(b) Election”). If the Section 83(b) Election is made, any gain subsequently recognized by the taxpayer (e.g., on a sale of the property after the taxpayer’s interest in the property has vested) is treated as capital gain (i.e., is not treated as compensation taxable at ordinary income rates).

Under current law, making a Section 83(b) Election requires the taxpayer to:

  • File the election with the IRS within 30 days after transfer of the unvested property (in the format specified in the Treasury Regulations and IRS guidance);
  • Deliver a copy of the election to the employer; and
  • Include a copy of the election with the taxpayer’s annual tax return for the year in which the election is made.

In the preamble to the Proposed Regulations, the IRS expressed concern that the requirement to include a copy of the Section 83(b) Election with the annual tax return prevents taxpayers from electronically filing their annual tax returns because commercial tax return services do not consistently provide a mechanism for submitting the election with an electronically filed tax return. In order to remove this obstacle to electronic filing, the Proposed Regulations eliminate the requirement that a copy of the Section 83(b) Election be included with the annual tax return. The Proposed Regulations would not change the requirement to file the election with the IRS within 30 days after a transfer of unvested property or the requirement to provide a copy of the election to the employer.

The Proposed Regulations would apply as of January 1, 2016, and would apply to property transferred on or after that date. Taxpayers may rely on the Proposed Regulations for property transferred on or after January 1, 2015.