Should a Nonresident Alien Make a §83(b) Election? (And Some
More Musings on FIRPTA)
By Kimberly S. Blanchard,
Esq.
Weil, Gotshal & Manges LLP, New York, NY
Occasionally, nonresident aliens (nonresidents) may receive stock
(or partnership interests) of U.S. issuers in compensatory transfers
in which the stock is subject to a “substantial risk of
forfeiture” within the meaning of §83 of the Code and the
regulations thereunder. Only very rarely will the nonresident have any
idea that the rules of §83 may alter the expected tax treatment
of the stock grant. This commentary addresses a few cases in which the
making, or not making, of a §83(b) election can have important
tax consequences to the recipient of the
stock.
Background: Unvested Compensatory Stock Is Not Treated as Owned by
the Transferee Until Vesting
The law is well-settled: When an employee or other service provider
receives stock that is subject to a substantial risk of forfeiture
within the meaning of §83,
he1 is not treated as the owner of
the stock for most tax purposes until the stock “vests” or
he makes an election under §83(b). Regs. §1.83-1(a) provides
that until property becomes substantially vested, “the
transferor shall be regarded as the owner of such property, and any
income from such property received by the employee … constitutes
additional compensation.”
Following this rule, Rev. Proc. 80-11 instructs a taxpayer who
receives dividends on restricted stock and who receives both a
1099-DIV and a W-2 to list the amount on Schedule B with a statement
that the income has been included in income as compensation in the
appropriate place on Form 1040, and not to include the amount in total
dividends on Schedule B or on the Form 1040. Rev. Rul. 83-22 and Rev.
Proc. 83-38 distinguished Rev. Proc. 80-11 and reached the opposite
conclusion where a §83(b) election was made (and concluded that
“the employee is considered to be the owner of the stock”
and “the employee is regarded as the owner of the stock,”
respectively).
More recently, Rev. Rul. 2005-39 concluded that, for purposes of
determining whether a §280G change in ownership or control has
occurred, whether restricted stock counts as outstanding depends on
whether a §83(b) election has been made. (Similarly, whether a
§83(b) election is made determines whether stock is considered as
held by the recipient for purposes of determining whether he is a
disqualified individual.)
Notice 2005-43 sets forth a proposed revenue procedure regarding
compensatory partnership interests (to go along with proposed
regulations under §83) and would adopt a similar fate for such
interests. The Notice states that “a partnership must treat as
unissued any substantially nonvested partnership interest transferred
in connection with the performance of services for which an election
under §83(b) has not been made.”
Nonresidents are subject to U.S. income tax only on certain types
of U.S.-source income and on income that is effectively connected with
the conduct of a U.S. trade or business. The source of services income
is where services are provided. Normally, therefore, a nonresident
will not be subject to U.S. tax on income from services, as long as
the services are provided outside of the United States. If services
are provided both within and without the United States, Treasury
regulations provide rules for determining what portion of the
compensation--including compensation realized upon vesting of
restricted stock or exercise of options--is sourced to the United
States.2
Application of the §83 Rules to Non-U.S. Service
Providers
If the service provider is a nonresident who receives stock of a
U.S. corporation and who performs services wholly outside the United
States, he would only rarely consider making a §83(b) election
(or have reason to know that §83 exists). There are two cases,
however, in which the issue might surface. First, the U.S. service
recipient may request that the nonresident file a §83(b) election
because it wishes to claim a current deduction under §83(h) where
the stock is issued at a discount to fair market value. This is a rare
case, because stock is not often issued at a significant discount and
because the future value of the deduction upon vesting is usually
expected to be greater than the deduction that would be available if
the §83(b) election were made.
Second, the nonresident may want to consider the possibility that
he may become a U.S. resident, or provide services in the United
States, at some point in time before the stock vests. Making the
election ensures that the service provider will not be subject to U.S.
tax upon vesting.
The nonresident who finds himself in this position is well advised
to consider his options carefully before filing any §83(b)
election. There are situations in which a nonresident service provider
will be far better off by refraining from making the §83(b)
election than he would be if the election were made. The first such
situation is where the stock is expected to pay dividends. The second
is where the stock would be a “U.S. real property
interest” within the meaning of §897, by virtue of the
issuer qualifying as a “U.S. real property holding
corporation” (USRPHC).
Dividends
Dividends on the stock of a U.S. issuer paid to a nonresident are
ordinarily subject to U.S. withholding tax at the rate of 30% (or
typically 15% under an applicable treaty). However, if the stock is
unvested and no §83(b) election has been made, any dividends paid
will not be treated as dividends, but will be treated as additional
compensation for services. If all of the nonresident's services are
performed outside the United States, or if a treaty applies with
respect to some services provided in the United States, no U.S. tax
will be payable with respect to dividends treated as
compensation.
FIRPTA
Ordinarily, a sale or other disposition of stock of a USRPHC is
subject to tax under FIRPTA. Withholding is equal to 10% of the gross
amount realized, although the final tax due is limited under current
law to 15% of the gain in the case of a seller who is an individual
and who has held the stock for more than one year. However, if a
nonresident service provider does not make a §83(b) election, and
can find a way to sell or dispose of his stock while it is still
unvested--a rare but not unprecedented event--he would be treated as
in receipt of compensation income in an amount equal to the gain
realized on such sale.3 Such
amount, being characterized as compensation for services, should not
be treated as gain from the disposition of a USRPI that is treated as
effectively connected income by reason of §897(a). Even if the
stock vests before a sale, the spread between its value at vesting and
the amount paid for the stock will be treated as compensation,
creating a tax-free step-up and thereby avoiding tax on any accrued
gain under FIRPTA.
Conclusion
Non-U.S. service providers who receive shares of U.S. stock as
compensation for services should carefully consider the pros and cons
of making, or not making, a §83(b) election. Similar
considerations may apply with respect to the receipt of unvested
compensatory interests in partnerships.
This commentary also will appear in the May 9, 2008, issue of
the Tax Management International Journal. For more information,
in the Tax Management Portfolios, see Utz, 384 T.M., Restricted
Property -- Section 83, Bissell, 907 T.M., U.S. Income Taxation
of Nonresident Alien Individuals, Rubin and Hudson, 912 T.M.,
Federal Taxation of Foreign Investment in U.S. Real Estate, and
Tello, 915 T.M., U.S. Withholding and Reporting Requirements
for Payments of U.S. Source Income to Foreign Persons, and in Tax
Practice Series, see ¶1150, Deferred Compensation, and
¶7120, Foreign Persons' U.S. Activities.
1
Or she, or it. For ease of reference, this note assumes the service provider is an individual, but the observations herein would apply equally if the service provider were a corporation or other entity.
2
Regs. §1.861-4(b). Even where a nonresident earns U.S.-source or effectively connected services income, the provisions of an otherwise applicable tax treaty may excuse him from having to pay U.S. tax.
3
Regs. §1.83-1(b)(1). Special rules apply to dispositions not at arm's length, such as gifts to family members, but the basic character of any gain as compensation for services remains unchanged. See Regs. §1.83-1(c). The reason that dispositions of unvested shares are rare is that to be unvested, property must be “nontransferable.” However, that term is a term of art as used in §83, such that stock will be treated as “nontransferable” if the transferee must take subject to the forfeiture restriction. Regs. §1.83-3(d). In rare cases, a buyer will buy unvested stock subject to a forfeiture restriction.
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