The IRS has published final regulations (TD 9779) under Section 83 regarding property transferred in connection with the performance of services. The regulations are effective as of July 26, 2016, and affect taxpayers who receive property in connection with their performance of services and elect to include the value of substantially nonvested property in income in the year of transfer.

The IRS received no comments on the underlying proposed regulations (REG-135524-14), issued in mid-July 2015. Therefore the final regulations adopt the proposed regulations without any modifications. (For more on the proposed regulations, see Tax Alert 2015-1395.{})

Background

Section 83(a) generally requires a taxpayer who receives property in return for performing services to report as income the difference between the fair market value of the property at the time it is no longer subject to a substantial risk of forfeiture, and the amount (if any) the taxpayer paid for the property.

Section 83(b) and Treas. Reg. Section 1.83-2 provide a mechanism for the service provider to elect to include the value of the property in gross income as of the transfer, notwithstanding the substantial risk of forfeiture. A Section 83(b) election may be beneficial because it begins the holding period for determining future capital gains and eliminates the compensation inclusion that would otherwise occur at the time that a substantial risk of forfeiture lapses (i.e., at the time that amounts become vested). Prior to the new final regulations, to make a Section 83(b) election, the service provider must file a written statement with the IRS within 30 days of receiving the property, provide a copy to the service recipient and include a copy of the previously filed election when filing the applicable year's tax return (Reg. Section 1.83-2(c)).

Final regulations

The final regulations provide that taxpayers are no longer required to include a copy of a Section 83(b) election with their tax return for the year in which the property subject to the election was transferred. Nonetheless, the preamble to the final regulations reminds taxpayers of "their general recordkeeping responsibilities" under Section 6001 "and more specifically of the need to keep records that show the basis of property owned by the taxpayer." In particular, a taxpayer must maintain, until the statute of limitations for their tax return expires, sufficient records to show the original cost of the property at issue and to support the tax treatment of the property as reported on the return.

The final regulations apply to property transferred on or after January 1, 2016. The regulations, however, finalized the proposed regulations without change; taxpayers may rely on the proposed regulations for transfers of property occurring in calendar year 2015 and later.

Implications

Currently, the IRS has not approved the use of electronic signatures for Section 83(b) elections. Moreover, there is no process for e-Filing a Section 83(b) election. Prior to the application of the final regulations, taxpayers who filed a Section 83(b) election in a tax year were not eligible to e-File their individual tax returns for the year. Because Section 83(b) elections are no longer required to be filed with the service provider's tax return, this barrier to e-Filing the annual tax return has been removed.

Taxpayers making Section 83(b) elections continue to be required to file a copy of the elections within the applicable 30-day deadline with the IRS office where the taxpayer files his or her return. Employers often assist their employees who are awarded restricted property with the preparation and filing of Section 83(b) elections. Failure of an employee to file a valid Section 83(b) election may cause the employee to recognize compensation income at the time the property becomes substantially vested. If an employer is unaware that an employee failed to make a valid Section 83(b) election, there may be exposure to the employer for failure to report and withhold compensation at the time of vesting.

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