Stocks

<div class="Section1">The 2017 tax reform legislation created a new IRC Section&nbsp;83(i) that changes the rules that govern certain stock options and restricted stock units (RSUs) that are granted to employees.<a href="#_ftn1" name="_ftnref1">¹</a> Under the 2017 tax reform legislation, employees are now permitted to defer gain on these benefits for up to five years.<div class="Section1"><br /> <br /> Generally, IRC Section&nbsp;83(a) requires that, when a taxpayer receives property in exchange for services, the value of the property is taxable when it becomes transferrable or when it is vested (basically, when it is no longer subject to a substantial risk of forfeiture). As a result, when an employee receives an equity grant, appreciation on the stock can be taxed at ordinary income tax rates during the time between granting and vesting. Section&nbsp;83(b) allows taxpayers to make an irrevocable election to pay income taxes on the unvested stock at its fair market value on the date of transfer (so that subsequent appreciation is taxed at capital gains rates). However, many employees who receive equity grants do not have the funds to make this election and cover the tax liability, especially with respect to companies where the stock is not readily tradeable (i.e., the employee cannot sell the stock to help pay the taxes).<br /> <br /> IRC Section&nbsp;83(i) allows employees who receive these specific types of equity grants to elect to defer taxation for five years after the stock vests.<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Essentially, this can be helpful to employees when the stock that will be transferred to them is not readily tradeable, making it potentially difficult to pay the associated taxes immediately.<br /> <br /> <hr><br /> <br /> The election must be made within 30 days after the date upon which the employee&rsquo;s rights in the stock are transferable or are no longer subject to a substantial risk of forfeiture (whichever is earlier).&nbsp;The election must be filed with the IRS and the employee must also provide a copy to the employer.<a href="#_ftn2" name="_ftnref2">²</a>&nbsp;The employer is required to provide notice of the potential to defer income to the employee receiving the grant. If a deferral election is made with respect to an incentive stock option, that option is treated as a nonqualified stock option for FICA tax purposes.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Only income taxes are deferred during the deferral period. Employment taxes (Social Security and Medicare taxes) still must be paid.<br /> <br /> <hr><br /> <br /> At the end of the deferral period, the employee recognizes income based upon the value of the stock on the vesting date (regardless of whether the value has decreased during the deferral period).<br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> While the eventual tax paid is based on the value of the stock at vesting, the holding period for long-term capital gains treatment will begin to run during the deferral period.&nbsp;Therefore, if the stock value increases during the deferral period, ordinary income tax rates will only apply to the stock value at the start of the deferral period.&nbsp;The remainder will be taxed at the lower long-term capital gains rates if the stock is not sold for at least one year.<br /> <br /> <hr><br /> <br /> Income must be recognized for the first taxable year that includes one of the following (1) the first date the qualified stock becomes transferable (including transferable to the employer), (2) the date the employee becomes an &ldquo;excluded employee,&rdquo; (3) the date on which any of the stock becomes readily tradeable on an established securities market, (4) five years after the first date the employee&rsquo;s right to the stock becomes substantially vested or (5) the date upon which the employee revokes the deferral election.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Under the rules that have been provided thus far, it does not appear that termination of employment with the employer will cause the deferral period to end.<br /> <br /> <hr><br /> <br /> &ldquo;Excluded employees&rdquo; include any individual (1) who was a one-percent owner of the corporation at any time during the 10 previous calendar years, (2) who is, or has ever been, CEO or CFO of the company (or has acted in that capacity), (3) who is a family member of an individual described in (1) or (2), or (4) who has been one of the four most highly compensated officers of the company for any of the 10 previous tax years.<a href="#_ftn5" name="_ftnref5">⁵</a> Employees must also agree to an escrow provision in order to take advantage of the new deferral option. All deferral stock must be held in an escrow arrangement established by the employer to qualify.<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong> Failure to establish an escrow account to hold the deferral stock provides employers with the option to compensate employees with stock, but preclude them from making the new Section&nbsp;83(i) election.&nbsp;The terms of the stock option or RSU can also provide that no Section&nbsp;83(i) election will be available.<br /> <br /> <hr><br /> <br /> The election is only available with respect to qualified stock, which means stock in an employee&rsquo;s employer that is (1) received in connection with the exercise of an option or in settlement of an RSU and (2) granted in connection with services that are being performed by the employee.&nbsp;The stock will no longer be qualified if the employee may sell the stock, or otherwise receive cash in lieu of the stock from, the corporation.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> To issue equity grants that qualify for the Section&nbsp;83(i) deferral election, the employer must be a private company that has a written plan in place stating that at least 80 percent of the employer&rsquo;s full-time U.S. employees will be granted stock options or RSUs on substantially the same terms.&nbsp;The number of shares granted to each employee need not be equal, so long as each employee is entitled to a more than de minimis amount. Rights and privileges with respect to the exercise of a stock option are not treated for this purpose as the same as rights and privileges with respect to the settlement of an RSU.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> <hr><br /> <br /> <strong>Planning Point:</strong>&nbsp;The IRS has released guidance clarifying that this 80 percent requirement is based only on stock options or RSUs granted in a particular calendar year. Further, the employer is required to take the total number of employees employed at any time during the year into account in calculating the 80 percent requirement, as well as all of the employees receiving grants, regardless of whether the person was employed at the beginning or the end of the year in question.<a href="#_ftn9" name="_ftnref9">⁹</a><br /> <br /> <hr><br /> <br /> All related entities are considered in determining whether the 80 percent requirement is satisfied.&nbsp;The definition of controlled group under IRC Section&nbsp;414(b) applies for purposes of determining corporations that are members of a controlled group (and are thus treated as a single corporation).<a href="#_ftn10" name="_ftnref10">¹⁰</a> Further, only corporations that make grants to employees are eligible under this provision (LLCs that elect partnership taxation are excluded).<br /> <br /> The election is not available if the company has repurchased any of its stock in the past year, unless at least 25 percent of the stock repurchased is stock that has been deferred under Section&nbsp;83(i) elections (and determination of which employees to repurchase the stock from is made on a reasonable basis). <a href="#_ftn11" name="_ftnref11">¹¹</a>If the company repurchases all Section&nbsp;83(i) stock, the 25 percent requirement and reasonable basis requirement are deemed to have been satisfied.<a href="#_ftn12" name="_ftnref12">¹²</a><br /> <br /> A transition rule provided that a corporation will be deemed to comply with this &ldquo;80 percent&rdquo; restriction if it complies with a reasonable good faith interpretation of the rules. Further, an employer will be treated as satisfying the notice requirements restriction if it complies with a reasonable good faith interpretation of the rules.&nbsp;This transition relief will apply until the IRS releases regulations or other guidance on the 80 percent rule and notice requirements (employers are now required to comply with the rules for calculating the 80 percent rule found in Notice 2018-97).<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> If the Section&nbsp;83(i) election is made, RSUs are not eligible for the IRC Section&nbsp;83(b) election. Further, qualified stock will not be treated as a nonqualified deferred compensation plan for Section&nbsp;409A purposes, but only with respect to employees who may receive qualified stock.<br /> <br /> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id=""></a> for a discussion of the notice and reporting requirements that apply with respect to the deferral election.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(4). Making this election is similar to making the Section&nbsp;83(b) election.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(1)(B).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(1)(B). Revocation of a deferral election will be as established by the Secretary.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(3)(B).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;&nbsp; Notice 2018-97.<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(2)(B).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(2)(C).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.&nbsp;&nbsp; Notice 2018-97.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(5).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(4)(B)(iii).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83I(i)(4)(C)(iii).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>.&nbsp;&nbsp; IRC &sect;&nbsp;83(i)(7)(g).<br /> <br /> </div></div><br />

<div class="Section1">A stock split is treated in the same manner as a stock dividend.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;Therefore, a stock split is generally a nontaxable event for the shareholder (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>).&nbsp;The tax basis and holding period of the &ldquo;new&rdquo; stock received in a stock split is determined as discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7510">7510</a>.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;305(a).<br /> <br /> </div></div><br />

<div class="Section1">No special tax rules apply if an investor realizes a <em>gain</em> in a wash sale of stock or other securities; rather, the sale will be taxed under the rules peculiar to both the type of disposition and to the particular stock or security sold. For the taxation of gain on treasury bills, bonds and notes, and municipal bonds, <em><em>see</em></em> respectively Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7626">7626</a>, Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7632">7632</a>, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7663">7663</a>. For taxation of gain on corporate obligations, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7628">7628</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7635">7635</a>. For taxation of stock, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7517">7517</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7522">7522</a>.<div class="Section1"><br /> <br /> On the other hand, to the extent that shares of stock or securities sold are replaced in a wash sale (as defined in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7536">7536</a>), any <em>loss</em> realized on the stock or securities sold may <em>not</em> be recognized for income tax purposes and, therefore, may not be used to offset capital gains or otherwise deducted. However, if the quantity of the stock or securities sold at a loss exceeds the quantity replaced, the loss realized on the excess shares or securities may be recognized as a capital loss for income tax purposes.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;1091(b);&nbsp;Treas. Reg. &sect;&nbsp;1.1091-1(c); Rev. Rul. 70-231, 1970-1 CB 171.<br /> <br /> </div></div><br />

<div class="Section1">No. Without the transfer of the underlying stock, a gift or gratuitous assignment of future dividends will not shift the taxability of the dividends away from the owner of the stock.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> The bona fide sale of future dividends for good and sufficient consideration will result in the dividends being taxed to the purchaser and not the shareholder; but this will accelerate rather than reduce the shareholder’s tax since the net sales proceeds must be reported by the shareholder-seller as ordinary income in the year of the sale.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   <em><em>See</em> Van Brunt v. Comm.</em>, 11 BTA 406 (1928); <em>Lucas v. Earl</em>, 281 U.S. 111 (1930).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   <em>Estate of Stranahan v. Comm.</em>, 472 F.2d 867 (6th Cir. 1973).<br /> <br /> </div>

<div class="Section1">A dividend paid in bonds, notes, or other obligations of the distributing corporation is treated as a dividend &ldquo;in kind&rdquo; and the obligations are treated as property received in a dividend distribution.<a href="#_ftn1" name="_ftnref1">¹</a> <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7503">7503</a> for the taxation of dividends &ldquo;in kind.&rdquo;<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;317(a);&nbsp;Treas. Reg. &sect;&nbsp;1.317-1.<br /> <br /> </div></div><br />

<div class="Section1">A <em>stock dividend</em> is a dividend paid in shares of stock of the distributing corporation to its shareholders with respect to its outstanding stock. A distribution of stock to compensate the recipient for services rendered, for goods provided, or in payment of a debt is not made with respect to the distributing corporation’s outstanding stock and, therefore, is not a stock dividend.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> A distribution of stock warrants (or other rights to acquire stock of the distributing corporation) is treated in the same manner as a stock dividend so long as the distribution of such warrants is made with respect to the corporation’s outstanding stock (and not as compensation for services, etc.).<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> A distribution of stock of the distributing corporation made with respect to outstanding stock rights or convertible securities of that corporation to the owners thereof will also qualify as a stock dividend.<a href="#_ftn3" name="_ftnref3">³</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 305(a); Treas. Reg. § 1.305-1.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 305(d); Treas. Reg. § 1.305-1(d).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.   IRC § 305(d).<br /> <br /> </div>

<div class="Section1">If a warrant to acquire stock in the distributing corporation is acquired in a dividend distribution, taxation to the recipient-shareholder depends on whether the dividend is taxable or not (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7509">7509</a>). If it is a nontaxable stock dividend, there is no immediate income taxation. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7511">7511</a> to determine the tax basis of a warrant acquired in a nontaxable stock dividend. If the dividend is taxable, it is treated as a dividend &ldquo;in kind,&rdquo; so that the amount that generally must be included in the recipient-shareholder&rsquo;s income is the fair market value of the warrant on the date of distribution.<a href="#_ftn1" name="_ftnref1">¹</a>&nbsp;This is also the warrant&rsquo;s tax basis (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7503">7503</a>).<div class="Section1"><br /> <br /> If a corporation distributes a warrant to acquire stock in another corporation, it is also taxed as a dividend in kind.&nbsp;The basis of the warrant to an individual shareholder is its fair market value, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7503">7503</a>.<br /> <br /> If a warrant is acquired through purchase, gift, or inheritance, there are no immediate income tax consequences.&nbsp;The tax basis of a warrant acquired in this manner is determined under general rules discussed in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="692">692</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; Treas. Reg. &sect;&nbsp;1.305-1(b).<br /> <br /> </div></div><br />

<div class="Section1">The term “wages” excludes remuneration received on account of the following: (1) a transfer of a share of stock to any individual pursuant to an exercise of an incentive stock option; or (2) any disposition by the individual of such stock. The exclusion applies to stock acquired pursuant to options exercised after October 22, 2004.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> Proposed regulations had provided that an individual exercising an incentive stock option would receive wages for FICA and FUTA purposes. However, in 2002, the IRS announced that until further guidance was issued, the Service would not assess the FICA or FUTA tax, or apply federal income tax withholding obligations, upon the exercise of the option or upon the disposition of the stock acquired by an employee pursuant to the exercise of an option.<a href="#_ftn2" name="_ftnref2">²</a> In AJCA 2004, Congress codified the exclusionary rule, above.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 3121(a)(22); Act § 251(d), AJCA 2004.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   REG-142686-01, 66 Fed. Reg. 57023 (11-14-2001); Notice 2002-47, 2002-2 CB 97. <em><em>See also</em></em> Notice 2001-72, 2001-2 CB 548, Notice 2001-73, 2001-2 CB 549.<br /> <br /> </div>

<div class="Section1">If the transfer of stock to an individual upon exercise of an incentive stock option was a <em>qualifying transfer</em> (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7546">7546</a>), then no taxable event occurs until the stock is disposed of.<a href="#_ftn1" name="_ftnref1">¹</a> At the time of disposition, the general rules for treatment of a sale of stock will apply; thus, the taxpayer will recognize capital gain or loss to the extent of the difference between the sale price of the stock and its adjusted basis. <em><em>See</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7517">7517</a> regarding the sale of stock, and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="702">702</a> for an explanation of the treatment of capital gains and losses.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;&nbsp; IRC &sect;&nbsp;421(a).<br /> <br /> </div></div><br />

<div class="Section1">Many dividend reinvestment plans offer participating shareholders an option to invest additional cash to purchase <em>at a discount</em> limited quantities of the distributing corporation’s stock. If a shareholder elects to do so, he must include as dividend income on his federal income tax return the difference between the fair market value of the stock on the dividend payment date and the optional payment. (Apparently, this would normally be the amount of the discount.) A shareholder’s tax basis in the shares purchased under this type of option is generally the shares’ fair market value on the dividend payment date.<a href="#_ftn1" name="_ftnref1">¹</a></div><br /> <div class="Section1"><br /> <br /> The holding period of stock purchased under the optional aspect of a dividend reinvestment plan begins on the day following the date the shares are purchased.<a href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   Rev. Rul. 78-375, 1978-2 CB 130.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   Rev. Rul. 76-53, 1976-1 CB 87.<br /> <br /> </div>