Probate & Trust Law Section Conference Manual ... - Minnesota CLE

The Well-Prepared Executive: Personal Wealth Preservation Strategies
the executive may not sell the stock under the
securities law for 6 months. Although the actual
value of the stock should be discounted from the
$20 trading value to reflect the 6 month lock-up, the
6 month lock-up is ignored for purposes of valuing
the stock under Section 83, resulting in the
executive being taxed on the full $20 trading value.
See Pledger v. Commissioner, 641 F.2d 287 (5th
Cir. 1981); Sakol v. Commissioner, 574 F.2d 694
(2d Cir. 1978). The only restriction that is taken
into account in determining value is one that by its
terms will never lapse, such as a buy-sell agreement.
IRC § 83(a).
b. Minority and Lack of Marketability
Discounts
Although restrictions on stock must be
ignored under IRC § 83, appropriate discounts for
minority interests and lack of marketability are
permitted in determining value for purposes of IRC
§ 83. See Theophilos v. Commissioner, 85 F.3d 440
(9th Cir. 1996)(remanding to Tax Court to
determine an appropriate minority discount). cf.
Morrow v. Commissioner, T.C. Memo 1995-18.
4. Sale of Stock
Appreciation in the stock that occurs after
the restricted stock vests is taxed as capital gain
when the executive sells the stock. If the executive
held the stock for at least one year from the vesting
date, then the 20% long-term capital gains rate will
apply.
5.
IRC § 83(b) election
a. The value of restricted stock may increase
substantially prior to vesting, resulting in a large
ordinary tax liability for the executive upon vesting.
Moreover, at the time the restricted stock becomes
vested it may still be illiquid, resulting in phantom
income to the executive (i.e., taxable income
b. An executive can avoid paying ordinary
income tax on appreciation that occurs between
grant of the restricted stock and vesting of the
restricted stock by making an election under IRC §
83(b) to recognize compensation income at the time
the restricted stock is granted. The amount of
compensation income is the difference between fair
market value of stock at time of grant less any
amount paid for stock. Fair market value is
determined without regard to any restrictions other
than restrictions which by their terms will never
lapse. An IRC § 83(b) election also starts the
executive’s holding period for capital gains and
§1202 purposes. IRC § 83(f).
c. If the §83(b) election is made when the
restricted stock is granted, any future appreciation in
stock value from grant date is taxed as capital gain
when the executive sells the stock. If the executive
holds the stock for one year from the original grant,
then the 15% long-term capital gains rate will apply.
d. The IRC § 83(b) election must be filed with
the applicable IRS Service Center within 30 days
after the executive receives the restricted shares.
This is an absolute deadline with no exceptions. In
TAM 199910010, the taxpayer failed to file the IRC
§ 83(b) election within 30 days of receipt of
restricted stock. The company canceled the original
shares and issued new shares under the same terms.
The taxpayer then made the IRC § 83(b) election for
the new shares within 30 days of receipt of the new
shares. The IRS ruled that the cancellation and
reissuance of the shares was a sham transaction and
thus the taxpayer had not made a timely IRC § 83(b)
election.
e. The IRC § 83(b) election can provide the
executive substantial tax benefits under the right
circumstances. The election is usually made when
the stock has little value when received, or when the
executive paid close to fair market value for the
stock, and the executive anticipates the stock value
will appreciate substantially during the vesting
period.
6. Imposing Vesting Provisions on Previously
Owned Stock Protective IRC § 83(b) Election
In many cases, founders and senior
executives of companies that are obtaining venture
capital funding are required to subject their existing
stock holdings to new vesting provisions. Because
the founder or executive continues to own the same
shares that he has always owned, there should be no
“transfer” of property that would trigger a taxable
event under IRC § 83. Some commentators have
raised the question whether the IRS would assert
that the founder or executive made a constructive
exchange of his old unrestricted stock for new
restricted stock that constitutes a transfer of property
for IRC § 83 purposes. When the restricted stock
becomes vested, the founder or senior executive
would have ordinary income equal to the value of
the stock at such time. To avoid this risk, tax
advisors recommend that the founder or executive
make a “protective” IRC § 83(b) election within 30
days of the imposition of the new vesting
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