Guidance on tax rules for stock purchased from an employer.
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Employers sometimes make their stock available for purchase by key employees or certain others who provide services, such as directors and consultants. On this page we’re talking about purchases other than under a stock option or an employee stock purchase plan (ESPP). Two very important rules apply in this case:
- If the stock is vested when you buy it, you must report compensation income at that time, equal to the value of the stock minus the amount you paid. See When Stock Is Vested.
- If the stock isn’t vested when you buy it, you must report compensation income when it vests unless you made the Section 83b Election. This is true even if you paid full value when you bought the stock.
The rules described here don’t apply if you bought the stock by exercising an incentive stock option and satisfy the special holding period for that stock. See Incentive Stock Options.
Buying vested stock
If your stock is vested when you buy it, you may have to report compensation income at that time. Generally you have compensation income if the amount you pay for the stock is less than its Fair Market Value. This rule applies if you’re exercising a nonqualified option, or if you’re simply making a “bargain purchase.”
Example: Your employer agrees to sell you 50 shares of stock for $20,000 when the value is $50,000, and the stock is vested when you receive it. You must report (and pay tax on) $30,000 of compensation income.
This rule does not apply if you purchase stock by exercising an incentive stock option.
If you’re an employee (not a non-employee director or consultant, for example) the income you report from this purchase is subject to withholding even though you didn’t receive any cash. See Withholding on Stock Compensation. If you’re not an employee, generally the compensation income you report from this purchase is subject to self-employment tax.
Buying restricted stock
There’s no income to report at the time you buy restricted stock (stock that isn’t vested) unless you make the Section 83b Election. Your situation is the same as someone who received a Grant or Award of Stock, except you have basis in the stock equal to the amount you paid. This means the amount of income you’ll have to report when you make a Section 83b Election will be smaller. This election is frequently very attractive where there’s a purchase of stock that isn’t vested.
Tax trap alert
You may not feel you need to worry about tax consequences if you pay full value for stock from your employer. Yet if the stock isn’t vested at the time of the purchase, your failure to make a Section 83b Election could be costly.
Example: You pay $40,000 to buy $40,000 worth of stock from your employer, agreeing that you’ll sell it back for $40,000 if your employment terminates within a year. This is a substantial risk of forfeiture — you can lose the benefit of any increase in the value of the stock — so the stock isn’t vested until a year passes. If the stock is worth $64,000 when it vests, you’ll have to report $24,000 of compensation income at that time.
If you made the Section 83b Election at the time you bought the stock, you would not have to report income when the stock vests. And in this case, the election is entirely free of cost.