Tax Facts
3623 / How is restricted stock taxed?
Taxation of restricted stock is governed by IRC Section 83, even after the enactment of Section 409A, if structured properly. This is because restricted stock must be structured and issued subject to a Section 409A substantial risk of forfeiture (in addition to a Section 83 substantial risk of forfeiture) that also makes it eligible to claim the Section 409A “short term deferral exception” to escape Section 409A coverage requirements. The distribution must be made during the 409A exception safe harbor time period to claim this exception to Section 409A ( Q 3541).
Section 83 restricted stock generally does not constitute taxable income to the employee at the time it is granted (unless at the time of the grant it is “substantially vested,” see below). An employee who receives restricted stock must include the fair market value of that stock in his or her income in the year the stock becomes “substantially vested.” The amount the employee paid for the restricted stock, if any, must be subtracted from this amount. Restricted stock becomes substantially vested in the year in which the stock becomes transferable or the stock is no longer subject to a Section 83 substantial risk of forfeiture.1
Within 30 days of receiving the restricted stock, an employee may elect under IRC Section 83(b) to be taxed on the fair market value of the stock currently, rather than in the year the stock becomes substantially vested. Any appreciation after the election is thereafter taxable as a capital gain. If the restricted stock is ultimately forfeited, no deduction is allowed for that forfeiture.2
Where restricted stock that is substantially vested is subjected to new restrictions that cause it to become substantially nonvested, the stock is not subject to IRC Section 83(b) in the absence of an exchange of stock. Where substantially vested stock is exchanged for substantially nonvested stock, the new restricted stock is subject to IRC Section 83(b).3
An employer is entitled to a corresponding deduction in the same amount and at the same time as the ordinary income recognized by the employee.4 Compensation paid in the form of restricted stock normally triggers the receipt of wages for the purpose of employment tax and withholding provisions in the amount of the income generated under IRC Section 83(a).5
On May 29, 2012, the IRS released proposed regulations clarifying the definition of “substantial risk of forfeiture”6 under Section 83, integrating more closely with the Section 409A definition of “substantial risk of forfeiture” and incorporating its ruling in Revenue Ruling 2005-48 (for details on the changes see Q 3622 and especially Q 3538). On February 25, 2014, the IRS released final regulations that are substantially similar to the proposed regulations. These regulations will apply to all transfers of property on or after January 1, 2013, though the final regulations may be relied on as to transfers after May 30, 2012.7
1. IRC § 83(a).
2. IRC § 83(b).
3. Rev. Rul. 2007-49, 2007-31 IRB 237.
4. IRC § 83(h).
5. Rev. Rul. 79-305, 1979-2 CB 350.
6. As noted several places in Tax Facts, there are currently seven definitions of “substantial risk of forfeiture” in the IRC (including the definition of “substantial limitation,” which historically has been referred to by attorneys and judges as a “substantial risk of forfeiture”). These seven definitions are usually similar but also not exactly the same (e.g., the Section 457(f) definition for ineligible nonqualified deferred compensation plans versus the definition for purposes of Section 409A). They frequently are additive to each other, which is helpful if a planner is aware there are more than one that is applicable. These multiple definitions create considerable confusion for all parties concerned trying to properly construct and administer compensation plans of all types. See Q 3538 for a listing of the seven.
7. Prop. Treas. Reg. § 1.83-3.
Section 83 restricted stock generally does not constitute taxable income to the employee at the time it is granted (unless at the time of the grant it is “substantially vested,” see below). An employee who receives restricted stock must include the fair market value of that stock in his or her income in the year the stock becomes “substantially vested.” The amount the employee paid for the restricted stock, if any, must be subtracted from this amount. Restricted stock becomes substantially vested in the year in which the stock becomes transferable or the stock is no longer subject to a Section 83 substantial risk of forfeiture.1
Within 30 days of receiving the restricted stock, an employee may elect under IRC Section 83(b) to be taxed on the fair market value of the stock currently, rather than in the year the stock becomes substantially vested. Any appreciation after the election is thereafter taxable as a capital gain. If the restricted stock is ultimately forfeited, no deduction is allowed for that forfeiture.2
Where restricted stock that is substantially vested is subjected to new restrictions that cause it to become substantially nonvested, the stock is not subject to IRC Section 83(b) in the absence of an exchange of stock. Where substantially vested stock is exchanged for substantially nonvested stock, the new restricted stock is subject to IRC Section 83(b).3
An employer is entitled to a corresponding deduction in the same amount and at the same time as the ordinary income recognized by the employee.4 Compensation paid in the form of restricted stock normally triggers the receipt of wages for the purpose of employment tax and withholding provisions in the amount of the income generated under IRC Section 83(a).5
On May 29, 2012, the IRS released proposed regulations clarifying the definition of “substantial risk of forfeiture”6 under Section 83, integrating more closely with the Section 409A definition of “substantial risk of forfeiture” and incorporating its ruling in Revenue Ruling 2005-48 (for details on the changes see Q 3622 and especially Q 3538). On February 25, 2014, the IRS released final regulations that are substantially similar to the proposed regulations. These regulations will apply to all transfers of property on or after January 1, 2013, though the final regulations may be relied on as to transfers after May 30, 2012.7
1. IRC § 83(a).
2. IRC § 83(b).
3. Rev. Rul. 2007-49, 2007-31 IRB 237.
4. IRC § 83(h).
5. Rev. Rul. 79-305, 1979-2 CB 350.
6. As noted several places in Tax Facts, there are currently seven definitions of “substantial risk of forfeiture” in the IRC (including the definition of “substantial limitation,” which historically has been referred to by attorneys and judges as a “substantial risk of forfeiture”). These seven definitions are usually similar but also not exactly the same (e.g., the Section 457(f) definition for ineligible nonqualified deferred compensation plans versus the definition for purposes of Section 409A). They frequently are additive to each other, which is helpful if a planner is aware there are more than one that is applicable. These multiple definitions create considerable confusion for all parties concerned trying to properly construct and administer compensation plans of all types. See Q 3538 for a listing of the seven.
7. Prop. Treas. Reg. § 1.83-3.
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