Property received for services.

• Author: Glass, Elliott

A general proposition of individual income tax planning is to delay the recognition of taxable income for as long as possible, thus delaying the tax as well. A second proposition is to try to convert ordinary income to long-term capital gain to get both a more favorable rate and possibly use capital losses, further reducing the tax cost of the income.

In the "property for services" arena these dual goals are very difficult to accomplish. Due to the unique nature of the rules in this area, it is often advantageous to recognize ordinary income at the earliest possible date in order to maximize the portion that will be reportable as long-term capital gain later. A recent case demonstrates that with the right facts, a favorable result can be obtained.

Sec. 83 and the regulations thereunder govern the tax treatment of the receipt of property for services. Not surprisingly, the general rule is that such a transaction generates ordinary income taxable on receipt of the property. A significant exception to this rule is Sec. 83(a), which postpones the recognition of income on property received for services that is subject to restrictions on transferability or substantial risk of forfeiture until the restrictions lapse or the property vests in the taxpayer.

Example: If an employer gives employee E a bonus of 1,000 shares of stock with a fair market value (FMV) of $20,000, the employee is taxed on $20,000 of ordinary income on receipt of the shares. Suppose instead that E is "given" the stock, but can only dispose of 500 shares immediately, with the balance being forfeited if he does not remain with the employer for one year. In that case, E must report $10,000 of ordinary income on receipt of the shares. With respect to the other 500 "restricted" shares, E will report income at the end of one year in an amount equal to the FMV of the shares at that time.

Another significant exception is Sec. 83(e)(3), which provides that the receipt of an option to acquire property is not immediately taxable unless the option has a readily ascertainable FMV. Regs. Sec. 1.83-7(b) defines options with readily ascertainable FMVs as those actively traded on an established market or other options in which the FMV can otherwise be measured with reasonable accuracy. In practice, this provision delays taxation until the option is exercised and the amount of income is measured by the excess of the value of the property received over the option's exercise price. Since most...