The IRS has issued proposed regulations that can be relied upon by taxpayers to eliminate the requirement that a copy of a Section 83(b) election must be attached to a taxpayer’s income tax return in order for it to be effective, applying for transfers on or after January 1, 2015. The IRS eliminated the requirement because tax return preparation software doesn’t consistently allow taxpayers to submit the election with electronically filed income tax returns.
The general rule when unvested property is received as compensation for services is taxable income is measured at the time the property becomes vested.
For example, XYZ Co. grants a nonqualified stock option to Jane Employee. Jane is granted the right to exercise the option before it is vested. (Vesting means Jane has all rights to the stock, including the right to sell it.) Jane exercises the option on June 1, 20X1 and the stock isn’t vested on that date.. The fair market value on that date is $1 per share, and the option price is also $1 per share. No income is taxable for 20X1. The stock vests on June 1, 20X2, when the fair market value is $11 per share. Jane has taxable wages income for 20X2 of $10 per share. The holding period for the stock starts on the vesting date.
Jane could have avoided having the increase in value after exercise taxed as wages by making a Section 83(b) election. When you make a Section 83(b) election, you are electing to disregard restrictions such as vesting at the date the property is received, which is the date of exercise for a nonqualified stock option. The election must be made within 30 days after the property is received, and it is irrevocable without the consent of the IRS once it is made. If Jane made a Section 83(b) election in the above example, there would be no taxable income when the option was exercised in 20X1 because the fair market value was the same as the option price. Any future appreciation for the stock would be taxed as a capital gain. The holding period for the stock would start on the date of exercise.
In the past, there were three requirements to make a valid election. (1) A written election must be filed at the IRS service center where tax returns are filed for the taxpayer within 30 days after the date the property is transferred; (2) a copy of the election must be given to the employer or entity for which services are performed; and (3) a copy of the election must be attached to the taxpayer’s income tax return for the year of the election.
Under the new proposed regulations, the last requirement has been eliminated.