Published: March 18, 2016
Oil and Gas Executives Should Consider Making 83(b) Elections This Year on Their Performance Shares
Missing out on 83(b) elections could mean missing out on saving tax dollars, especially if you work in the oil and gas industry.
It has been a volatile start to the year in the market, and an even rougher last twelve months for anyone in the energy business. As of the end of February, West Texas Intermediate Crude oil traded near all-time lows at $26.21. Realizing how stressful this is for our professional and executive clients, we want to emphasize how this could be a tax opportunity for energy professionals that receive restricted stock. Some energy companies refer to restricted stock by various other names like performance shares, stock awards, or plan awards.
Before getting into the potential tax benefits of an 83(b) election, it is important to understand how restricted stock units are granted, vested, and taxed. Companies have a lot of leeway in structuring how they compensate their employees. Most large energy companies use restricted stock units to align the employee’s compensation with the performance of the company over an extended period of time. Let’s look at the tax ramifications of a standard non-83(b) election example:
John receives a restricted stock grant of 1,000 shares of company stock in 2016. The current share price for the company stock is $50 (current value of the grant is $50,000). The stock vests in 2019 and the company stock price is significantly higher since oil rebounded over the last three years. It is now trading at $100 per share ($100,000 value). John pays taxes at his ordinary income tax rate for $100,000 of company stock. Let’s say his marginal tax rate is 35%, thus he pays $35,000 in taxes in 2019.
The 83(b) election allows an employee to pay ordinary income taxes when they receive the grant and then pay long term capital gains on any growth between the grant date and the vesting date. If an individual has a high level of conviction that the granted company stock is going to be worth significantly more down the road, then he or she should consider making the 83(b) election. Let’s look at an example:
In this alternative scenario, John’s adviser informed him of the 83(b) election, since oil was near recent all-time lows. They both believe oil would trade higher three years out, so John made the 83(b) election within 30 days of receiving his stock grant. John paid ordinary income taxes in 2016 on the value of the grant amount. $50,000 * 35% = $17,500. The stock vests in 2019 at $100 per share. John does not owe any taxes in 2019 upon the vest date since he paid those three years earlier in 2016. John then sells the company stock soon after it vests. He has to pay long-term capital gains taxes on the growth in the value of the stock between the grant date and the vest date ($100,000-$50,000 = $50,000). This $50,000 growth is taxed at his long-term capital gains rate of 15%, causing him to pay $7,500 in taxes upon the sale, for a total tax bill of $25,000.
In this illustration, John saved $10,000 in taxes by making the 83(b) election!
The 83(b) election can lead to a huge tax savings, but it is not for everyone. Listed below are a few important factors to consider to determine if an 83(b) election is right for you:
1. Taxes must be paid when the individual receives the grant instead of when the stock vests.
2. The Individual must have the capital to pay the taxes up front.
3. The 83(b) election must be made within 30 days of the stock grant.
4. If the employee does not end up receiving the company stock three years down the road, there is no way to recoup the paid taxes; they are gone.
5. Most people will need the help of a CPA to record the 83(b) election correctly.
6. Market risk must be taken into account.
For more information please speak with your advisor, or reach out to a member of the WJA team.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss. Past performance is not a guarantee of future results. Investors should be aware that it is not possible to accurately predict all of the changes that may occur in the economy or the stock market.
Although this information has been gathered from sources believed to be reliable, it cannot be guaranteed. Willis Johnson & Associates does not offer tax or legal advice. Federal tax laws are complex and subject to change. As with all matters of a tax or legal nature, you should consult with your tax or legal counsel for advice.
The information provided is not intended to be a substitute for specific individualized tax, legal or estate planning advice. Individual situations will vary. We can assist you in making informed decisions. No single solution meets all investor’s needs. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
Willis Johnson & Associates is a registered investment advisor. Insurance and additional investment advisory services offered through Willis Johnson & Associates.
Nick Johnson, CFA®, CFP®
Nick Johnson believes that financial planning is more than numbers on a balance sheet and a standardized process. People are unique and should be treated as such.
As Vice President and Wealth Manager at Willis Johnson & Associates, his goal is to really get to know his clients, all the while providing a proactive approach to comprehensive wealth management.