If a taxpayer buys or receives stock subject to restrictions then special tax rules apply. Generally, no tax is owed on the stock until it is no longer restricted. In the year the restrictions are lifted, you must report the difference between the amount you paid for the stock (if any) and the fair market value at the time the restrictions are lifted. The difference is reported as wages on Form W-2. Rules for restricted stock are not limited to employees; they also apply to independent contractors who are compensated for services provided.
For example, you buy 100 shares of stock at $10 a share ($1,000 total) when your employer’s stock has a market value of $100 a share, with the restriction that if you leave your job within five years the stock must be sold back at $10 a share. Five years later, restrictions are lifted and the stock is selling for $200 a share ($20,000 to buy 100 shares). You will report ordinary income of $19,000 ($20,000 fair market value minus $1,000 paid for the 100 shares). Your basis in the stock is now $20,000.
Taxpayers may elect to be taxed in the year they receive restricted stock. Called a Section 83(b) election, it can be made by filing a signed statement with the IRS no later than 30 days after the stock was received. The statement must specify that you are making the election under Section 83(b), and include: your name, address, Social Security number, the year for which you are making the election, a description of the stock, the restrictions on the stock, the date the stock was received, the fair market value of the stock on the date it was received, and your cost (if any) for the stock. A copy must be given to the company who you received the restricted stock from.
If the Section 83(b) election is made, income is reported as wages on Form W-2 based on the value of the stock when it is received. When the stock is eventually sold capital gain or loss is reported.
For example, you buy 100 shares of stock at $20 a share ($2,000 total) when your employer’s stock has a market value of $50 a share ($5,000 to buy 100 shares), with the restriction that if you leave your job within five years the stock must be sold back at $20 a share. If a Section 83(b) election is filed with the IRS then you report ordinary income of $3,000 ($5,000 fair market value minus $2,000 paid for the 100 shares). Your basis in the stock is $5,000.