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You've Made it When...

Retirement Funding

...The boss calls you in to talk about a "non-qualified" plan. 

A non-qualified plan is one that doesn't meet the Department of Labor's rules for employee benefit plans and normally they are set-up for key members of a company.  So, if your boss is talking about a non-qualified plan, you're doing all right.  The down side is that non-qualified plans are tricky and you can significantly change your tax bill by the decisions you make. 

For today, we'll talk about Restricted Stock Plans, one type of non-qualified plans.  Under a Restricted Stock Plan an employee (normally highly compensated or key personnel) is granted shares of stock (normally company stock) for free or a reduced price.  In line with the name, the stock is restricted.  Normally, the restriction is based on an amount of time passing or serving as employee for a certain amount of time (or both) and you won't be able to sell the stock until the restriction is lifted.  At the time of grant (when you buy or receive the stock) there are no tax implications.  This is because you have a substantial risk of forfeiture of the benefit as you get nothing if you don't meet the requirement to lift the restriction.  But there could be tax implications when the restriction ends.  Unless...

Let's start with the general rule.  Under the general rule when the restriction ends (the stock vests), you will be taxed on the difference between what you paid for the stock and the fair market value on that date.  Under the general rule the income is ordinary income and taxed at your marginal tax rate.  In other words, if the stock goes up in value, you will be paying taxes on capital gains at your marginal rate...not a good deal for you.  It is also important to note that you're not receiving any "real" income when this happens only a right.  You'll have to pay that tax with "real" money.

Section 83(b). Under Section 83(b) of the Tax Code you have the option to pay some taxes now to save taxes in the future.  If you select to exercise the Section 83(b) election you will pay taxes on the discount (the difference between the price and current fair market value) when you are granted the restricted stock.  In some cases there may not be a discount element (often the case in start-ups) when you are granted the stock.  This income is taxed at your marginal tax rate.  If the 83(b) election is taken, then there is no tax implications when the restriction is lifted and taxes will only be due when the previously restricted stock is sold.  And all the gains will be taxed as capital gains and almost certainly the capital gains tax rate will be lower than your marginal tax rate.

There is a limited amount of time to exercise the 83(b) option.  More precisely, you have 30 days from the transfer of the stock.  There are also specific paperwork requirements.

If the boss starts talking about Restricted Stock Plans, make sure you give us a call before you agree to anything.

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