Property for Services Series: Part 3 of 5
We know from Property for Services Part 1 and Part 2 that property received for services are taxable to the service provider and deductible for the business paying the service provider. We also learned about the timing of the income and how to change that timing using an 83(b) election. The next big question is, “How much is taxable?”
Section 83(a) has a simple formula. The taxable amount is “the fair market value of such property over the amount paid for such property.” In simple mathematical terms:
Fair Market Value – Amount Paid = Compensation for Services
For most clients, property for services is most prevalent in equity compensation with their employer. The fair market value of the stock is either established as a publically traded security or determined by the employer’s appropriate leadership. In almost all cases, it is not a number the service provider independently determines.
The employer must determine the value as if the substantial risk of forfeiture is not present. If we consider the timing rules of the income, this makes sense if our timing is either:
- When the substantial risk of forfeiture no longer exists, or
- At grant with an 83(b) election ignoring the substantial risk of forfeiture.
In both scenarios, the taxation is at a time when the substantial risk of forfeiture has lifted or deemed to no longer exist.
A client will only make an 83(b) election if the client believes the value of the stock will increase during the vesting period and they intend to fulfill the vesting requirements. What happens if an 83(b) election is made and then vesting conditions are not met? The client will forfeit some or all of the stock. Unfortunately, no deduction (loss) is allowed under section 83(b)(1)(B). This limitation is only for the compensation for services income. The client will only get a loss for any amount paid for the property.
Knowing how much is taxable is useful not only to your client, but also to you as their financial professional. Elevate CPA Group works with RIA firms to help increase the value of their business. If you have questions about property for services taxation, give us a call.