Section 83 of the Internal Revenue Code works to delay the tax consequence of a transaction that is subject to a condition until that condition is met. The most common example is when an executive receives a grant of shares that are subject to vesting restrictions that lapse over time. In that case, Section 83 of the Code will delay the tax treatment until the restrictions lapse and the shares are fully “earned.”

Delaying taxes is good, right?

Well, in the case of fast-growing, start-up companies, the delay may result in unexpected and disastrous taxes. If the value of the grant is not determined until after the conditions lapse, our executive will face a large tax bill because, presumably, the value of his fast-growing company will have shot through the roof in the meantime. If, however, the tax treatment were not delayed, the tax that would have been due would be negligible, at most. That’s because the value of the shares at the time of initial grant would have been equal to the nominal price that our executive likely paid for them.

Let me give you an example.

Let’s say that our executive paid $0.01 per share for 400,000 shares of stock that are subject to equal annual vesting over a period of four years. At the end of the first, second, third, and fourth years the shares are worth $1.00, $5.00, $10.00, and $20.00, respectively.

Absent Section 83, our executive would pay no tax at all. After all, he has received no income because the amount he paid for the shares ($0.01) was likely the same as the value of those shares ($0.01) on the date he received them.

But because of Section 83, our executive’s tax treatment is deferred, and at the end of the first year he will be deemed to receive income of $99,000 (the difference between what he paid, $0.01, and what the shares are worth on that date, $1.00, multiplied by the number of shares then freed of restriction). And likewise, in years two, three, and four he will receive income of $499,000, $999,000, and $1,999,000 for the number of shares whose restrictions lapse at the end of the second, third, and fourth years, respectively. And the company will be required to pay FICA taxes, too, with respect to all that income.

Ouch!

What’s an executive to do? Section 83(b) comes to the rescue!

Section 83(b) allows our executive to elect to treat the shares as if there were no conditions subjecting them to divestment. In that case, the taxability of the initial stock grant would be determined as of the date of grant. Our executive then pays income tax of, well, $0.00, because he paid exactly what the shares were worth at that time.

How, and when, is the election made? Well, let’s take that up in my next post.

The SEC has charged a lawyer who formerly worked at one of Silicon Valley’s better-known law firms with participating in an insider-trading scheme. Allegedly, the lawyer collected information about pending deals and passed it on to a compatriot via a mutual acquaintance, using disposal cell phones and other anonymous means of communication.

The SEC alleges that Matthew H. Kluger, who formerly worked at Wilson Sonsini Goodrich & Rosati, and Garrett D. Bauer did not have a direct relationship with each other, but were linked only through a mutual friend who acted as a middleman to facilitate the illegal scheme.

via SEC Charges Corporate Attorney and Wall Street Trader in $32 Million Insider Trading Ring.

What’s a business in the medical marijuana industry supposed to do when it comes time to raise capital and, therefore, must disclose its risk factors?  Well, it can answer honestly: 

Some of the business activities of some of our customers, while believed to be compliant with applicable state law, are illegal under federal law.  If our customers are closed by law enforcement authorities, it will materially and adversely affect our business.

The medicinal cannabis industry is currently conducted in the 15 states, plus the District of Columbia, that have passed laws either decriminalizing or legalizing the medicinal use of cannabis.  However, under United States federal law, the possession, use, cultivation, and transfer of cannabis is illegal.  The federal, and in some cases state, law enforcement authorities have frequently closed down dispensaries and investigated and/or closed physician offices that provide medicinal cannabis recommendations.  To the extent that an affected dispensary or physician office is a customer of ours, it will affect our revenue, and to the extent that it has an impact on new dispensaries and physician offices entering the medicinal cannabis industry, it would have a material affect on our business and operations.

via General Cannabis Prospectus.

This just in:

The SEC alleges that Alternate Energy Holdings Inc. (AEHI) has raised millions of dollars from investors in Idaho and throughout the U.S. and Asia while fraudulently manipulating its stock price through misleading public statements that conceal the secret profits reaped by its CEO Donald L. Gillispie and Senior Vice President Jennifer Ransom. Gillispie has touted the company as a tremendous investment opportunity that could rival Exxon Mobil in profitability, despite the fact that AEHI has essentially no revenue and minimal operations.

via SEC Brings Fraud Charges Against Self-Described Idaho Nuclear Power Company (Press Release No. 2010-249; December 16, 2010.

Apparently the SEC became alarmed when AEHI (a company aiming to build the nation’s first nuclear plant in years) peppered the public with frequent press releases (87 in 2010 alone) in an apparent effort to drive up its stock price. This, and evidence that the CEO reported minimal compensation ($133,000) when he allegedly received nearly six times more than that, was too much for the SEC to bear.