Taxes and Business Decisions 335the tax is payable. Of course, Congress is not being entirely altruistic in this
case; the amount taxed when the stock vests is not the difference between
what the employee pays for it and its value when first received by the employee
but the difference between the employee’s cost and the stock’s value at the
vesting date. If the value of the stock has increased, as everyone involved has
hoped, the IRS receives a windfall. Of course, the employer receives a com-
pensating deduction at the time of taxation, and further growth between the
vesting date and the date of sale is taxed upon sale at appropriate capital gain
rates. No deduction is then available to the employer.
Recognizing that allowing the employee to pay a higher tax at a later time
is not an unmixed blessing, Congress has provided that an employee who re-
ceives restricted stock may, nonetheless, elect to pay ordinary income tax on
the difference between its value at grant and the amount paid for it, if the em-
ployee files notice of that election within 30 days of the grant date (the so-
called 83b election). Thus, the employee can choose for herself which gamble
to accept.
This scenario can result in disaster for the unaware employee. Assume
that Morris and Brad resolve their differences by allowing Brad to have an eq-
uity stake in the corporation, if he is willing to pay for it. Thus, Brad purchases
5% of the corporation for its full value on the date he joins the corporation,
say, $5.00 per share. Since this arrangement still provides incentive in the form
of a share of growth, Morris insists that Brad sell the stock back to the corpo-
ration for $5.00 per share should he leave the corporation before he has been
employed for three years. Brad correctly believes that since he has bought
$5.00 shares for $5.00 he has no taxable income, and he reports nothing on his
income tax return that year.
Brad has failed to realize that despite his paying full price, he has re-
ceived restricted stock. As a result, Congress has done him the favor of impos-
ing no tax until the restrictions lapse. Three years from now, when the shares
may have tripled in value and have finally vested, Brad will discover to his hor-
ror that he must include $10.00 per share in his taxable income for that year.
Despite the fact that he had no income to declare in the year of grant, Brad
must elect to include that nullity in his taxable income for that year by filing
such an election with the IRS within 30 days of his purchase of the stock.
In situations in which there is little difference between the value of stock
and the amount an employee will pay for it (e.g., in start-up companies when
stock has little initial value), a grant of restricted stock accompanied by an 83b
election may be preferable to the grant of an ISO, since it avoids the alterna-
tive minimum tax which may be imposed upon exercise of an ISO.
VACATION HOME
Morris had much reason to congratulate himself on successfully acquiring the
plastics-molding operation as well as securing the services of Brad through an