The Tax Problem With Using Nonrecourse Loans To Buy Restricted Stock
Executives frequently desire to start their capital gains holdings period with respect to their equity compensation awards immediately upon receipt of the awards. This generally cannot be accomplished if the executive receives stock options (the exception being the receipt of an immediately exercisable stock option, which is exercised and a Section 83(b) election is filed if the shares are subject to vesting).
The goal of starting the capital gains holding period upon receipt of an equity compensation award can be accomplished with a restricted stock award provided the stock is fully paid for and vested upon receipt or a Section 83(b) election is filed. However, if a loan is used to pay for the stock, and the loan is non-recourse, the goal of starting the capital gains holding period may very well be thwarted because the IRS will likely deem the transaction to be the grant of an option--not the receipt of stock--until the note is paid down (and treat the pay down of the note as the exercise of the option, with the tax consequences that accompany that).
Treasury Regulation Section 1.83-3(a)(2) provides as follows:
“In addition, if the amount paid for the transfer of property is an indebtedness secured by the transferred property, on which there is no personal liability to pay all or a substantial part of such indebtedness, such transaction may be in substance the same as the grant of an option. The determination of the substance of the transaction shall be based upon all the facts and circumstances. The factors to be taken into account include the type of property involved, the extent to which the risk that the property will decline in value has been transferred, and the likelihood that the purchase price will, in fact, be paid. See also Sec. 1.83-4(c) for the treatment of forgiveness of indebtedness that has constituted an amount paid.”
From the IRS: When 'Too Good to Be True' Very Well May Be: Funding Business Startups with Plan Assets
"With recent events in the financial markets putting a squeeze on business credit, many aspiring entrepreneurs may search for novel ways to acquire business capital. One that has gained IRS’s attention, and coverage in the press, is to withdraw money from existing retirement accounts and then channel it into a new retirement plan. On October 1, 2008, the IRS released initial guidelines on the acceptability of these arrangements."
For more, read here.
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