Fair market value of 83b election for performance based stock
Doing so with RSUs triggers punitive taxation to the employee under the tax rules for deferred compensation. When employees are awarded restricted stock, they have the right to make what is called a "Section 83 b " election.
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If they make the election, they are taxed at ordinary income tax rates on the "bargain element" of the award at the time of grant. If the shares were simply granted xtock the employee, then the bargain element is their full value. If some consideration is paid, then the tax is based on the difference between what is paid and the fair market value at the time of the grant. If full price is paid, there is no tax. Any future change in the value of the shares between the filing and the sale is then taxed as capital gain or loss, not ordinary income.
An employee who does not make an 83 b election must pay ordinary income taxes on the difference between the amount paid for the shares and their fair market value when the restrictions lapse.
Subsequent changes in value are capital gains or losses. Recipients of RSUs are not allowed to make Section 83 b elections. The employer gets a tax deduction only for amounts on which employees must pay income taxes, regardless of whether a Section 83 b election is made. A Section 83 b election carries some risk.
If the employee makes 83g election and pays tax, but the restrictions never lapse, the employee does not get the taxes paid refunded, nor does bassd employee get the shares. Restricted stock accounting parallels option accounting in most respects. If the bases restriction is time-based vesting, companies account electoon restricted stock by first determining the total compensation cost at the time the award is made. However, no option pricing model is used. If the employee buys the shares at fair value, no charge is recorded; if there is a discount, that counts as a cost.
The cost is then amortized over the period of vesting until the restrictions lapse. Because the accounting is based on the initial cost, companies with low share prices will find that a vesting requirement for the award means their accounting expense will be very low. If vesting is contingent on performance, then the company estimates when the performance goal is likely to be achieved and recognizes the expense over the expected vesting period. If the performance condition is not based on stock price movements, the amount recognized is adjusted for awards that are not expected to vest or that never do vest; if it is based on stock price movements, it is not adjusted to reflect awards that aren't expected to or don't vest.
Restricted stock is not subject to fog new deferred compensation plan rules, but RSUs are. Both essentially are bonus plans that grant not stock but rather the right performqnce receive an award based on the value of the company's stock, hence the terms perrormance rights" and "phantom. Phantom stock provides a cash or stock bonus based on the value of a stated number of shares, to be paid out performancee the end of a specified period of time. SARs may not have a specific settlement date; like options, the employees may have flexibility in when to choose to exercise the SAR. Phantom stock may offer dividend equivalent payments; SARs would not.
When the payout is made, the value of the award is taxed as ordinary income to the employee and is deductible to the employer. Some phantom plans condition the receipt of the award on meeting certain objectives, such as sales, profits, or other targets. These plans often refer to their phantom stock as "performance units. Careful plan structuring can avoid this problem. Because SARs and phantom plans are essentially cash bonuses, companies need to figure out how to pay for them. Even if awards are paid out in shares, employees will want to sell the shares, at least in sufficient amounts to pay their taxes.
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Does the company just make perfprmance promise to pay, or does it really put aside the funds? If the award is paid in stock, is there a market for the stock? Bwsed it is only a promise, will employees believe the benefit is as phantom as the stock? If it is in real funds set aside for this purpose, the company will be putting after-tax dollars aside and not in the business. Many small, growth-oriented companies cannot afford to do this. The fund can also be subject to excess accumulated earnings tax. On the other hand, if employees are given shares, the shares can be paid for by capital markets if the company goes public or by acquirers if the company is sold. Phantom stock and cash-settled SARs are subject to liability accounting, meaning the accounting costs associated with them are not settled until they pay out or expire.
For cash-settled SARs, the compensation expense for awards is estimated each quarter using an option-pricing model then trued-up when the SAR is settled; for phantom stock, the underlying value is calculated each quarter and trued-up through the final settlement date. Phantom stock is treated in the same way as deferred cash compensation. However, transferability rarely exists without elimination of substantial risk of forfeiture. Therefore, it is important to understand the vesting schedule. The gross income realized by the employee upon vesting is treated as compensation. Section 83 a calculates includible gross income as follows: Fair market value FMV of such property on the date the employee vests, over the amount if any paid for such property.
Additionally, any subsequent appreciation or depreciation of value in the stock is treated as a capital gain or loss. To summarize, Section 83 applies to property transferred in connection with the performance of services. The property becomes includible in gross income on the date it is either not subject to substantial risk of forfeiture or is freely transferable. The amount includible is determined by the fair market value on that date less the amount paid for the property, if any.
The character of the income recognized is ordinary and treated as wages subject to payroll taxes. Making the Section 83 b Election Rather than wait until vesting, an employee may elect to report in income, the excess of the FMV of the restricted stock over consideration paid in the year the stock is granted. This election is called the Section 83 b election election. There are a few things that employees and tax advisers must be aware of. First, when an employee decides to make an election, the election must be filed with the IRS no later than 30 days after the date the property was transferred. In addition to the aforementioned filing requirements, the employee must also submit a copy with his employer.
83(b) Election: Tax Consequences of Restricted Stock Purchases
There are also potential disadvantages to making a Section 83 833b Election. One disadvantage is that, if the taxpayer later forfeits the Equity, it will not be allowed a deduction for any amount it reported as income at the time of transfer or for any additional taxes it paid as a result of making the election. For example, after the taxpayer makes such an election, the Internal Revenue Service may decide that the markwt market value of the Equity at the time of transfer was greater than the value reported on the Section 83 b Election and, consequently, that the amount of the compensation income was greater than the taxpayer reported. However, if the taxpayer over-reported the value of the Equity at the time of transfer, the taxpayer cannot revoke its earlier election and lower the value of the Equity and its compensation income.
Not Making the 83 b Election If the taxpayer does not make the Section 83 b Election, in any taxable year in which Equity vests the taxpayer will be required to include in its gross income as ordinary income the difference between the fair market value of the Equity at the time such Equity vests and the price it paid for the Equity. As a result, income that likely would have been taxable at capital gain rates upon sale if the taxpayer had made a Section 83 b Election would be taxable at ordinary income rates upon vesting.