The IRS recently announced various 2024 inflation-adjusted federal tax amounts that affect individual taxpayers.

Most of the federal income tax rate bracket thresholds are about 5.4% higher than for 2023. That means that you can generally have about 5.4% more income next year without owing more to the federal government.

Standard deduction

Here are the inflation-adjusted standard deduction numbers for 2024 for those who don’t itemize:

• $14,600 if you’re single or use married filing separate status (up from $13,850 in 2023).
• $29,200 if you’re married and file jointly (up from $27,700).
• $21,900 if you’re a head of household (up from $20,800).

Older taxpayers and those who are blind are entitled to additional standard deduction allowances. In 2024 for those age 65 or older or blind, the amounts will be: $1,550 for a married taxpayer (up from $1,500 in 2023) and $1,950 for a single filer or head of household (up from $1,850 for 2023).

For an individual who can be claimed as a dependent on another taxpayer’s return, the 2024 standard deduction will be the greater of: 1) $1,300 (up from $1,250 for 2023) or 2) $450 (up from $400 for 2023) plus the individual’s earned income, not to exceed $14,600 (up from $13,850 for 2023).

Ordinary income and short-term capital gains

Here are the 2024 inflation-adjusted bracket thresholds for ordinary income and net short-term capital gains:

• 10% tax bracket: $0 to $11,600 for singles, $0 to $23,200 for married joint filers, $0 to $16,550 for heads of household;
• Beginning of 12% bracket: $11,601 for singles, $23,201 for married joint filers, $16,551 for heads of household;
• Beginning of 22% bracket: $47,151 for singles, $94,301 for married joint filers, $63,101 for heads of household;
• Beginning of 24% bracket: $100,526 for singles, $201,051 for married joint filers, $100,501 for heads of household;
• Beginning of 32% bracket: $191,951 for singles, $383,901 for married joint filers, $191,951 for heads of household;
• Beginning of 35% bracket: $243,726 for singles, $487,451 for married joint filers and $243,701 for heads of household; and
• Beginning of 37% bracket: $609,351 for singles, $731,201 for married joint filers and $609,351 for heads of household.

Long-term capital gains and dividends

Here are the 2024 inflation-adjusted bracket thresholds for net long-term capital gains and qualified dividends:

• 0% tax bracket: $0 to $47,025 for singles, $0 to $94,050 for married joint filers, and $0 to $63,000 for heads of household;
• Beginning of 15% bracket: $47,026 for singles, $94,051 for married joint filers, and $63,001 for heads of household; and
• Beginning of 20% bracket: $518,901 for singles, $583,751 for married joint filers and $551,351 for heads of household.

Gift and estate tax

The annual exclusion for gifts made in 2024 will be $18,000 (up from $17,000 for 2023). That means you can give away up to $18,000 to as many individuals as you wish without incurring gift tax or using up any of your unified federal gift and estate tax exemption.

In 2024, the unified federal gift and estate tax exemption will be $13,610,000 (up from $12,920,000 for 2023).

For gifts made in 2024, the annual exclusion for gifts to a noncitizen spouse will be $185,000 (up from $175,000 in 2023).

Conclusion

This article only covers some of the inflation-adjusted tax amounts. There are others that may potentially apply, including: alternative minimum tax parameters, kiddie tax amounts, limits on the refundable amount of the Child Tax Credit, limits on the adoption credit, IRA contribution amounts, contributions to your company’s retirement plan and health savings account amounts. Various other inflation-adjusted amounts may affect your tax situation if you own an interest in a sole proprietorship or a pass-through business. Contact us with questions.

© 2023

Is your business depreciating over 30 years the entire cost of constructing the building that houses your enterprise? If so, you should consider a cost segregation study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). In most cases, a business depreciates a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — including equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Frequently, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases, the distinction between real and personal property is obvious. For example, computers and furniture are personal property. But the line between real and personal property is not always clear. Items that appear to be “part of a building” may in fact be personal property. Examples are removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, decorative lighting and signs.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. These include reinforced flooring that supports heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment and dedicated cooling systems for data processing rooms.

Identifying and substantiating costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

Speedier depreciation tax breaks

The Tax Cuts and Jobs Act (TCJA) enhanced certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other changes, the law permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

In addition, the TCJA expanded 15-year-property treatment to apply to qualified improvement property. Previously, this tax break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. And the law temporarily increased first-year bonus depreciation from 50% to 100% in 2022, 80% in 2023 and 60% in 2024. After that, it will continue to decrease until it is 0% in 2027, unless Congress acts.

Making favorable depreciation changes

It isn’t too late to get the benefit of faster depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return you file, that will result in automatic IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not the best move for every business. Contact us to determine whether this strategy would work for your business. We’ll judge whether a study will result in tax savings that are greater than the costs of the study itself.

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The Corporate Transparency Act (CTA) was signed into law to fight crimes commonly associated with illegal business activities such as terrorist financing and money laundering. If your business can be defined as a “reporting company” under the CTA, you may need to comply with new beneficial ownership information (BOI) reporting rules that take effect on January 1, 2024.

Who’s who?

A reporting company includes any corporation, limited liability company or other legal entity created through documents filed with the appropriate state authorities. A reporting company may also be any private entity formed in a foreign country that’s properly registered to do business in a U.S. state.

Reporting companies must provide information about their “beneficial owners” to the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury. A beneficial owner is someone who, directly or indirectly, exercises substantial control over a reporting company, or who owns or controls at least 25% of its interests. Indirect control is often exhibited by a senior officer or person with authority over senior officers.

The CTA does exempt a wide range of entities from the BOI reporting rules — including government units, nonprofit organizations and insurers. Notably, an exemption was created for “large operating companies” that:

• Employ more than 20 employees on a full-time basis,
• Have more than $5 million in gross receipts or sales (not including receipts and sales from foreign sources), and
• Physically operate in the United States.

However, many of these businesses need to comply with other reporting requirements.

What info must be provided?

The BOI reporting requirements are extensive. Reporting companies must file a report with FinCEN that includes the entity’s legal name (or any trade or doing-business-as name), address, jurisdiction where the entity was formed and Taxpayer Identification Number.

Reporting companies must also submit the name, address, date of birth and “unique identifying number information” of each beneficial owner. A unique identifying number may be a U.S. passport or state driver’s license number. An image of the document containing the identifying number must be included in the filing.

In addition, the CTA requires reporting companies to provide identifying information about their “company applicants.” A company applicant is defined as someone who’s responsible for:

• Filing the documents that created the entity (for a foreign entity, this is the person who directly files the document that first registers the foreign reporting company to conduct business in a U.S. state), or
• Directing or controlling the filing of the relevant formation or registration document by another individual.

Note: This rule often encompasses legal representatives acting in a business capacity.

When to file?

Reporting companies have either 30 days or one year from the effective date of January 1, 2024, to comply with the CTA. Reporting companies created or registered before the effective date have one year to file their initial reports with FinCEN. Those created or registered on or after January 1, 2024, will have 30 days upon receipt of their creation or registration documents to file initial reports.

After initially filing, reporting companies have 30 days to file an updated report reflecting any changes to previously reported BOI. In addition, reporting companies must correct inaccurate BOI in previously filed reports within 30 days after the date they become aware of the error.

Who can help?

With the effective date closing in quickly, now’s the time to determine whether your business is a nonexempt reporting company that must comply with the BOI reporting rules. We can help you make this determination in consultation with your legal advisors.

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If you’re planning to start a business or thinking about changing your business entity, you need to determine what will work best for you. Should you operate as a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation? There are many issues to consider.

Currently, the corporate federal income tax is imposed at a flat 21% rate, while individual federal income tax rates currently begin at 10% and go up to 37%. The difference in rates can be alleviated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, and some estates and trusts.

Individual rate caveats: The QBI deduction is scheduled to end in 2026, unless Congress acts to extend it, while the 21% corporate rate is not scheduled to expire. Also, noncorporate taxpayers with modified adjusted gross incomes above certain levels are subject to an additional 3.8% tax on net investment income.

Organizing a business as a C corporation instead of a pass-through entity may reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.

More to take into account

There are other tax-related factors to take into consideration. For example:

• If most of the business profits will be distributed to the owners, it may be preferable to operate the business as a pass-through entity rather than a C corporation, since the shareholders will be taxed on dividend distributions from the corporation (double taxation). In contrast, owners of a pass-through entity will only be taxed once, at the personal level, on business income. However, the impact of double taxation must be evaluated based on projected income levels for both the business and its owners.
• If the value of the assets is likely to appreciate, it’s generally preferable to conduct business as a pass-through entity to avoid a corporate tax when the assets are sold or the business is liquidated. Although corporate level tax will be avoided if the corporation’s shares, rather than its assets, are sold, the buyer may insist on a lower price because the tax basis of appreciated business assets cannot be stepped up to reflect the purchase price. That can result in much lower post-purchase depreciation and amortization deductions for the buyer.
• If the business is a pass-through entity, an owner’s basis in his or her interest in the entity is stepped-up by the entity income that’s allocated to the owner. That can result in less taxable gain for the owner when his or her interests in the entity are sold.
• If the business is expected to incur tax losses for a while, you may want to structure it as a pass-through entity so you can deduct the losses against other income. Conversely, if you have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable for the business to be a C corporation, since it’ll be able to offset future income with the losses.
• If the owner of a business is subject to the alternative minimum tax (AMT), it may be preferable to organize as a C corporation, since corporations aren’t subject to the AMT. Affected individuals are subject to the AMT at 26% or 28% rates.

As you can see, there are many factors involved in operating a business as a certain type of entity. This only covers a few of them. For more details about how to proceed in your situation, consult with us.

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There’s a common misconception that owning assets jointly with a child or other heir is an effective estate planning shortcut. While this strategy has a certain appeal, it can invite a variety of unwelcome consequences that may quickly outweigh any potential benefits.

Owning an asset — such as real estate, a bank or brokerage account, or a car — with your child as “joint tenants with right of survivorship” offers some advantages. For example, when you die, the asset automatically passes to your child without the need for more sophisticated estate planning tools and without going through probate.

But it can also create a variety of costly headaches, including:

Avoidable transfer tax exposure. If you add your child to the title of property you already own, it may be considered a taxable gift of half the property’s value. And when you die, half of the property’s value will be included in your taxable estate.

Increased income tax. As a joint owner, your child loses the benefit of the stepped-up basis enjoyed by assets transferred at death, exposing him or her to higher capital gains tax.

Exposure to creditors. The moment your child becomes a joint owner, the property is exposed to claims of the child’s creditors.

Loss of control. Adding your child as an owner of certain assets, such as bank or brokerage accounts, enables him or her to dispose of them without your consent or knowledge. And joint ownership of real property prevents you from selling it or borrowing against it without your co-owner’s written authorization.

Unintended consequences. If your child predeceases you, the assets will revert back in your name alone, requiring you to come up with another plan for their disposition.

Unnecessary risk. When you die, your child receives the property immediately, regardless of whether he or she has the financial maturity and ability to manage it.

These problems may be mitigated or avoided with one or more properly designed trusts.

© 2023

At the very least, your estate plan should include a legally valid will governing the disposition of assets upon your death. But comprehensive estate planning often goes much further. For instance, you may provide for transfers of assets to a living trust (also known as a revocable trust) to supplement your will. For many, the best part of using a living trust is that the trust assets don’t have to pass through probate.

You can take an additional step by creating a pour-over will. In a nutshell, a pour-over will specifies how assets you didn’t transfer to a living trust during your life will be transferred at death.

Complementary documents

As its name implies, any property that isn’t specifically mentioned in your will is “poured over” into your living trust after your death. The trustee then distributes the assets to the beneficiaries under the trust’s terms.

The main purpose of a pour-over will is to maximize the benefits of a living trust. But attorneys also tout the merits of using a single legal document — a living trust — as the sole guiding force for an estate plan.

To this end, a pour-over will serves as a conduit for any assets that aren’t already in the name of the trust or otherwise distributed. The assets will be distributed to the trust.

This setup offers the following benefits:

Convenience. It’s easier to have one document controlling the assets than it is to “mix and match.” With a pour-over will, it’s clear that everything goes to the trust, and then the trust document is used to determine who gets what.

Completeness. Generally, everyone maintains some assets outside of a living trust. A pour-over will addresses any items that have fallen through the cracks or that have been purposely omitted.

Privacy. In addition to the convenience of avoiding probate for the assets that are titled in the name of the trust, this type of setup helps to keep a measure of privacy that isn’t available when assets are passed directly through a regular will.

There is, however, one disadvantage to consider. As with any will, your executor must handle specific bequests included in the will, as well as the assets being transferred to the trust through the pour-over provision, before the trustee takes over. (Exceptions for pour-over wills may apply in certain states.) While this may take months to complete, property transferred directly to a living trust can be distributed within weeks of the testator’s death.

The role of trustee

After the executor transfers the assets to the trust, it’s up to the trustee to do the heavy lifting. The executor and trustee may be the same person and, in fact, they often are.

The responsibilities of a trustee are similar to those of an executor with one critical difference: they extend only to the trust assets. The trustee then adheres to the terms of the trust.

Account for all your assets

The benefits of using a living trust are many. Pairing it with a pour-over will may help wrangle any loose assets that you purposely (or inadvertently) didn’t transfer to the living trust. Your attorney can provide more information.

© 2023

To ensure that a trust operates as intended, it’s critical to appoint a trustee that you can count on to carry out your wishes. But to avoid protracted court battles in the event the trustee isn’t doing a good job, consider giving the trust beneficiaries the right to remove and replace the trustee.

What’s the role of a trustee?

A trustee is the person who has legal responsibility for administering a trust on behalf of the trust’s beneficiaries. Depending on the trust terms, this authority may be broad or limited.

Generally, trustees must meet fiduciary duties to the beneficiaries of the trust. They must manage the trust prudently and treat all beneficiaries fairly and impartially. This can be more difficult than it sounds because beneficiaries may have competing interests. The trustee must balance out their needs when making investment decisions.

The decision about naming a trustee is similar to the dilemma of choosing an executor. The responsibilities require great attention to detail, financial acumen and dedication. Because of the heavy reliance on investment expertise, choosing a professional over a family member or friend is often recommended. At the very least, make it clear to the trustee that he or she may — and should — rely on professionals as appropriate.

What’s considered “cause?”

If you don’t provide the trust’s beneficiaries the option to remove the trustee, their only recourse would be to petition a court to remove the trustee for cause. The definition of “cause” varies from state to state, but common grounds for removal include:

• Fraud, mismanagement or other misconduct,
• A conflict of interest with one or more beneficiaries,
• Legal incapacity,
• Poor health, or
• Bankruptcy or insolvency if it would affect the trustee’s ability to manage the trust.

Not only is it time consuming and expensive to go to court, but most courts are hesitant to remove a trustee that was chosen by the trust’s creator. That’s why including a provision in the trust document that allows your beneficiaries to remove a trustee without cause if they’re dissatisfied with his or her performance may be a good idea. Alternatively, you may want to authorize your beneficiaries to remove a trustee under specific circumstances outlined in the trust document.

Other options

If you’re concerned about giving your beneficiaries too much power, you may want to include a list of successor trustees in the trust document. That way, if the beneficiaries end up removing a trustee, the next person on the list takes over automatically, rather than the beneficiaries choosing a successor.

Alternatively, or in addition, you could appoint a “trust protector” with the power to remove and replace trustees and make certain other decisions regarding management of the trust. Contact us for additional information on the role a trustee plays.

© 2023

If you’re facing a serious cash shortfall, one possible solution is to take an early withdrawal from your traditional IRA. That means one before you’ve reached age 59½. For this purpose, traditional IRAs include simplified employee pension (SEP-IRA) and SIMPLE-IRA accounts.

Here’s what you need to know about the tax implications, including when the 10% early withdrawal penalty tax might apply.

Penalty may be avoided

In almost all cases, all or part of a withdrawal from a traditional IRA will constitute taxable income. The taxable percentage depends on whether you’ve made any nondeductible contributions to your traditional IRAs. If you have, each withdrawal from a traditional IRA consists of a proportionate amount of your total nondeductible contributions. That part is tax-free. The proportionate amount of each withdrawal that consists of deductible contributions and accumulated earnings is taxable. If you’ve never made any nondeductible contributions, 100% of a withdrawal is taxable.

Wide variety of exceptions

Unless one of these 11 exceptions applies, there will be a 10% early withdrawal penalty tax on the taxable portion of a traditional IRA withdrawal taken before age 59½.

1. Substantially equal periodic payments (SEPPs). These are annual annuity-like withdrawals that must be taken for at least five years or until the you reach age 59½, whichever comes later. Because the SEPP rules are complicated, consult with us to avoid pitfalls.

2. Withdrawals for medical expenses. If you have qualified medical expenses in excess of 7.5% of your adjusted gross income, the excess is exempt from the penalty tax.

3. Higher education expense withdrawals. Early withdrawals are penalty-free to the extent of qualified higher education expenses paid during the same year.

4. Withdrawals for health insurance premiums while unemployed. This exception is available to an IRA owner who has received unemployment compensation payments for 12 consecutive weeks under any federal or state unemployment compensation law during the year in question or the preceding year.

5. Birth or adoption withdrawals. Penalty-free treatment is available for qualified birth or adoption withdrawals of up to $5,000 for each eligible event.

6. Withdrawals for first-time home purchases. Penalty-free withdrawals are allowed to an account owner within 120 days to pay qualified principal residence acquisition costs, subject to a $10,000 lifetime limit.

7. Withdrawals by certain military reservists. Early withdrawals taken by military reserve members called to active duty for at least 180 days or for an indefinite period are exempt from the 10% penalty.

8. Withdrawals after disability. Early withdrawals taken by an IRA owner who is physically or mentally disabled to the extent that the owner cannot engage in his or her customary gainful activity or a comparable gainful activity are exempt from the penalty tax. The disability must be expected to lead to death or be of long or indefinite duration.

9. Withdrawals to satisfy certain IRS debts. This applies to early IRA withdrawals taken to pay IRS levies against the account.

10. Withdrawals after death. Withdrawals taken from an IRA after the account owner’s death are always exempt from the 10% penalty. However, this exemption isn’t available for funds rolled over into the surviving spouse’s IRA or if the surviving spouse elects to treat an IRA inherited from the deceased spouse as the spouse’s own account.

11. Penalty-free withdrawals for emergencies coming soon. The SECURE 2.0 law adds a new exception for certain distributions used for emergency expenses, which are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. Only one distribution of up to $1,000 is permitted a year and a taxpayer has the option to repay it within three years. This provision is effective for distributions made after December 31, 2023.

Plan ahead

Since most or all of an early traditional IRA withdrawal will probably be taxable, it could push you into a higher marginal federal income tax bracket. You may also owe the 10% early withdrawal penalty and possibly state income tax too. Note that the penalty tax exceptions generally have additional requirements that we haven’t covered here. Contact us for more details.

© 2023

If you read the Internal Revenue Code (and you probably don’t want to!), you may be surprised to find that most business deductions aren’t specifically listed. For example, the tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is defined as one that’s helpful or appropriate. For example, let’s say a car dealership purchases an automated external defibrillator. It may not be necessary for the operation of the business, but it might be helpful and appropriate if an employee or customer suffers cardiac arrest.

It’s possible for an ordinary expense to be unnecessary — but, in order to be deductible, an expense must be ordinary and necessary.

In addition, a deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (Keep in mind that the Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained the 50% deduction for business meals.)

Examples of taxpayers who lost deductions in court

Not surprisingly, the IRS and courts don’t always agree with taxpayers about what qualifies as ordinary and necessary expenditures. Here are three 2023 cases to illustrate some of the issues:

1. A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but didn’t provide required details including each vehicle’s ownership, cost and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the U.S. Tax Court found they didn’t show any related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)
2. The Tax Court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)
3. A physician specializing in gene therapy had multiple legal issues and deducted legal expenses of $360,295 for two years on joint Schedule C business tax returns. The Tax Court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

Proceed with caution

The deductibility of some expenses is clear. But for other expenses, it can get more complicated. Generally, if an expense seems like it’s not normal in your industry — or if it could be considered fun, personal or extravagant in nature — you should proceed with caution. And keep careful records to substantiate the expenses you’re deducting. Consult with us for guidance.

© 2023

Restricted stock awards are a popular way for companies to offer equity-oriented executive compensation. Some businesses offer them instead of stock option awards. The reason: Options can lose most or all of their value if the price of the underlying stock takes a dive. But with restricted stock, if the stock price goes down, your company can issue you additional restricted shares to make up the difference.

Restricted stock basics

In a typical restricted stock deal, you receive company stock subject to one or more restrictions. The most common restriction is that you must continue working for the company until a certain date. If you leave before then, you forfeit the restricted shares, which are usually issued at minimal or no cost to you.

To be clear, the restricted shares are transferred to you, but you don’t actually own them without any restrictions until they become vested.

Tax rules for awards

What are the tax implications? You don’t have any taxable income from a restricted share award until the shares become vested — meaning when your ownership is no longer restricted. At that time, you’re deemed to receive taxable compensation income equal to the difference between the value of the shares on the vesting date and the amount you paid for them, if anything. The current federal income tax rate on compensation income can be as high as 37%, and you’ll probably owe an additional 3.8% net investment income tax (NIIT). You may owe state income tax too.

Any appreciation after the shares vest is treated as capital gain. So, if you hold the stock for more than one year after the vesting date, you’ll have a lower-taxed long-term capital gain on any post-vesting-date appreciation. The current maximum federal rate on long-term capital gains is 20%, but you may also owe the 3.8% NIIT and possibly state income tax.

Special election to be currently taxed

If you make a special Section 83(b) election, you’ll be taxed at the time you receive your restricted stock award instead of later when the restricted shares vest. The income amount equals the difference between the value of the shares at the time of the restricted stock award and the amount you pay for them, if anything. The income is treated as compensation subject to federal income tax, federal employment taxes and state income tax, if applicable.

The benefit of making the election is that any subsequent appreciation in the value of the stock is treated as lower-taxed, long-term capital gain if you hold the stock for more than one year. Also, making the election can provide insurance against higher tax rates that might be in place when your restricted shares become vested.

The downside of making the election is that you recognize taxable income in the year you receive the restricted stock award, even though the shares may later be forfeited or decline in value. If you forfeit the shares back to your employer, you can claim a capital loss for the amount you paid for the shares, if anything.

If you opt to make the election, you must notify the IRS either before the restricted stock is transferred to you or within 30 days after that date. We can help you with election details.

Important decision

The tax rules for restricted stock awards are pretty straightforward. The major tax planning consideration is deciding whether or not to make the Section 83(b) election. Consult with us before making that call.

© 2023