IRC 83 -c (3) and its application to vesting and exercises


Does IRC 83 c-3 ever defer the tax liability from vesting of Restricted stock and RSUs and exercises of ESOs?

Below is what the Ninth Circuit Court of Appeals said about it in the case Strom v. U.S from 2011.

Nos. 09-35175, 09-35197. Decided: April 06, 2011



BERZON, Circuit Judge:


"Ordinarily, when an employee is compensated with non-statutory stock options that do not have a readily ascertainable fair market value at the time of the grant, the employee realizes income for tax purposes upon exercising the options.1 See 26 U.S.C. §§ 83(a) & (e)(3)-(e)(4); 26 C.F.R. § 1.83-7(a).

The taxpayer is taxed on an amount equal to the fair market value of the stock on the date of exercise minus the option price paid for the stock. See 26 C.F.R. §1.83-1(a)(1); id. §1.83- 7(a)

Internal Revenue Code § 83(c)(3), however, allows taxpayers to defer recognition and valuation of income so long as a profitable sale of the stock acquired through the exercise of the options "could subject a person to suit under section 16(b) of the Securities Exchange Act of 1934." 26 U.S.C. § 83(c)(3). 

Section 16(b), in turn, forbids a corporate insider from profiting on a purchase made within six months of a sale (or a sale made within six months of a purchase) of the corporation's stock. See 15 U.S.C. § 78p(b). 

If a taxpayer is permitted to defer tax consequences under IRC § 83(c)(3), the taxpayer will be later taxed on an amount equal to the fair market value of the stock on the date that    § 83(c)(3) no longer applies minus the option price paid for the stock. See 26 U.S.C. § 83(a); 26 C.F.R. § 1.83-1(a)(1)."

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So the highest authority that has addressed the issue claims that there is a tax deference until the risk of a 16 (b) violation by a sale of stock is no longer there. The deference could be as long as 6 months after the non exempt purchase.

The IRS in a Bulletin from March 2014 stated that the following:


Specifically, practitioners asked whether the purchase of shares in a transaction not exempt from section 16(b) of the Securities Exchange Act of 1934 prior to the exercise of a stock option that would not otherwise give rise to section 16(b) liability would defer taxation of the stock option exercise.

Treasury and the IRS do not believe that such a non-exempt purchase of shares would defer taxation of the subsequent stock option exercise. This result is consistent with Example 3 of § 1.83-3(j)(2). In response to these requests for clarification, Treasury and the IRS have revised Example 4 of proposed regulation § 1.83-3(j)(2) to address the situation raised."


So the purchase of shares in a transaction not exempt from section 16(b) of the Securities Exchange Act of 1934 prior to the exercise of a stock option that would not otherwise give rise give rise to section 16(b) liability would not defer taxation of the stock option exercise.


And the purchase of shares in a transaction not exempt from section 16(b) of the Securities Exchange Act of 1934 prior to the exercise of a stock option that would give rise to section 16(b) liability would defer taxation of the stock option exercise.

Some attorneys cite certain examples that the IRS created, which these attorneys do not understand, as authority that precludes the operation of IRC 83(c )

John Olagues

Edited Wed, Jun 14, 2017 8:23 PM

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