Computing the Tax Impact of a Sec. 83(b) Election

Editor:
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Arlington, VA

Editor's note: This case study has been adapted from "Tax Planning for High Income Individuals," 2nd edition, by Anthony J. Dechellis, Douglas L. Weinbrenner, Catherine A. Roeder and Patrick L. Young, published by Practitioners Publishing Company, Fort Worth, Tex., 2002 ((800) 323-8724; www.ppcnet.com).

Facts: Tom Henderson entered into a restricted stock plan with his employer, CNB Communications, Inc. (CNB). Under the plan, the company transferred to Tom 5,000 shares of stock for $10 per share on Jan. 1, 2002. At the time of the transfer, the stock's fair market value was $50 per share. Tom will be subject to a binding commitment to return the stock if he leaves CNB for any reason within five years from the date of the transfer. Tom anticipates selling the stock in 10 years.

Analysis

Because it is subject to a substantial risk of forfeiture, the stock is restricted. Tom must decide whether to make a Sec. 83(b) election to recognize income immediately. Tom's tax adviser assembles the following information:

Conclusion

Based on this analysis, Tom would have almost $50,000 of additional after-tax funds if he makes the Sec. 83(b) election. Regardless of making the election, Tom recognizes a total of $960,000 of income relative to the receipt and ultimate sale of the restricted stock. But by making a Sec. 83(b) election, more of this income is taxed as long-term capital gain ($760,000 versus $505,000). Of course, the decision to make a Sec. 83(b) election depends on certain assumptions made when the restricted stock is received. A significant change in any of the relevant factors (e.g., future value of the stock and applicable ordinary- and capital-gain tax rates) can have a dramatic effect on the analysis.