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"Section 83" Nonsense

Silver-bullet fantasist leading the naive past a mountain of CtC evidence

A NEW VERSION OF "SILVER-BULLET" FANTASY has lately been circulating briskly within the "tax honesty movement". This one is the notion that section 83 of the tax code is the long-sought mystical secret word by which the mis-application of the tax will be undone.

The theory grows out of ignorance (willful or otherwise) of section 83, which is only about stock transfers as compensation for services rendered. It also grows out of ignorance about the actual nature of the tax, which does not tax labor, or property-- but instead taxes the exercise of privilege (and without regard to how it is exercised, whether laboriously or otherwise).

The theorists look at section 83 of the IRC, which provides that when property is transferred in connection with the performance of services, the difference between the fair market value of that property (once firmly owned by the recipient) over what the recipient paid for it (if anything) "shall be included in the gross income of the person who performed the services". They then imagine that the taxable portion of their pay is now only the excess of the amount received over what is imagined to be one's own cost of labor-- which most folks would say is $0.

But these things are not what section 83 is about. Here is how the purpose and application of section 83 is explained by the 9th Circuit in 1984:

9. Resolution of the legal issue presented here requires an understanding of section 83's background and operation. Congress enacted section 83 in 1969 in response to the existing disparity between the tax treatment of restricted stock plans and other types of deferred compensation arrangements. S. Rep. No. 552, 91st Cong., 1st Sess. 120-21, reprinted in 1969 U.S. Code Cong. & Ad. News 2027, 2150-51 (Senate Report). Prior to 1969, an individual purchasing restricted stock was taxed either when the restrictions lapsed or when the stock was sold in an arm's length transaction. Tax was imposed upon the difference between the purchase price and the fair market value at the time of transfer or when the restrictions lapsed, whichever was less. See Cohn v. Commissioner, 73 T.C. 443, 446 (1979). This had both tax deferral and tax avoidance advantages over, for example, employer contributions to an employee's pension or profit sharing trust, which were immediately taxable in the year of receipt. H.R. Rep. No. 413, 91st Cong., 1st Sess. 86-87, reprinted in 1969 U.S. Code Cong. & Ad. News 1645, 1733-34 (House Report); Senate Report at 120-21, reprinted in 1969 U.S. Code Cong. & Ad. News 2027, 2150-51.

10. Section 83 resolved this disparity by requiring the taxpayer either to elect to include the "excess" of the fair market value over the purchase price in the year the stock was transferred, or to be taxed upon the full amount of appreciation when the risk of forfeiture was removed. 26 U.S.C. Secs. 83(a), 83(b). See generally Sobeloff, Payment of Compensation in the Form of Restricted Property: Problems of Employer and Employee--The Rules of New Code Section 83, 28 Inst. on Fed. Tax'n 1041, 1042-43 (1970). By its terms, the statute applies when property is: (1) transferred in connection with the performance of services; (2) subject to a substantial risk of forfeiture; and (3) not disposed of in an arm's length transaction before the property becomes transferable or the risk of forfeiture is removed.

Alves v. C.I.R., 734 F.2d 478, (9th Cir. 1984)

See also this case from the 2nd Circuit in 2011, and a couple of very explicit Tax Court rulings debunking the attempted use of section 83 to exclude compensation for labor from the tax here and here.

THE FACT IS, THE "SECTION 83" THEORY IS A RE-PACKAGING of an old errant notion of a "property basis in labor", which holds that labor is personal property which is exchanged at par for pay, making the pay not a gain and therefore (for some reason) not taxable. Again, this theory is born of ignorance of the real nature of the tax, in which it is not understood that it is neither the labor, nor the pay for labor being taxed, but the privilege being exercised when certain distinguished, tax-entity-connected labor (or other activities) are being performed.

It is true that in the actual structure of the tax, "gain" is a necessary element in the measure of the taxable activity conducted. But because it is the voluntary exercise of federally-taxable privilege being taxed under that actual structure, Congress-- the privilege-grantor-- gets to decide what qualifies as relevant "gain" and "cost". Except for certain demonstrable business expenses and the like, what Congress allows to be taken as "cost" is the amount of that year's "personal exemption(s)", along with a variety of possibly-available deductions and credits.

Further, conveniently unremarked by the peddlers of this theory is the fact that, even if their misconstruction of the "property" with which section 83 concerns itself were correct, nothing in the section says that the excess in value described is to be considered the ONLY thing to be included "in the gross income of the person who performed the services." In fact, section 83 is but one of 18 sections from chapter 1 of Title 26 U.S.C. gathered under the subheading, "Items specifically included in gross income". Further still, the definition of "Gross Income" at section 61 says:

 "[G]ross income means all income from whatever source derived, including (but not limited to) the following items: (1) Compensation for services, including fees, commissions, fringe benefits, and similar items; (2) Gross income derived from business; (3) Gains derived from dealings in property; (4) Interest; (5) Rents; (6) Royalties; (7) Dividends; (8) Alimony and separate maintenance payments; (9) Annuities; (10) Income from life insurance and endowment contracts; (11) Pensions; (12) Income from discharge of indebtedness; (13) Distributive share of partnership gross income; (14) Income in respect of a decedent; and (15) Income from an interest in an estate or trust."

And by the way, let's apply common sense to the plain language of section 83. Looking at that language in subparagraph (a) we see:

(a) General rule

If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of—

(1) the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever occurs earlier, over

(2) the amount (if any) paid for such property, shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture, whichever is applicable. The preceding sentence shall not apply if such person sells or otherwise disposes of such property in an arm’s length transaction before his rights in such property become transferable or not subject to a substantial risk of forfeiture.

Those promoting the "Section 83" nonsense want their dupes to imagine that the "property" being spoken of in the section is labor. And yet, look at how this "property" is discussed in the section: "the person having the beneficial interest in such property"; "the beneficial interest in such property are transferable or are not subject to a substantial risk of forfeiture"; "if such person sells or otherwise disposes of such property in an arm’s length transaction before his rights in such property become transferable"... Does it sound like labor is being spoken of here? How about we get rational: It is obviously stock being spoken of, here.

The purveyors of this nonsense produce only excerpts of cases in supposed support of their arguments. These excerpts are offered due to their inclusion of expansive language seeming to declare that section 83 applies to all compensation, and to everyone.

But the portions of these rulings which would make clear what the courts are speaking of are omitted. Concealed by the "section 83" folks is that in these cases, the only compensation being discussed is that of stock options and the like, just as is described in the law.

UNFORTUNATELY, THOSE TAKEN IN BY "SECTION 83" NONSENSE are due for trouble. Among other things, unlike the truth about the tax revealed in CtC, which has forced the IRS to resort to frivolous hoaxes as pretexts for its sporadic efforts to discourage and evade educated claimants, the "basis in labor" notion is an actual current official "frivolous list" item:

(4) Wages, tips, and other compensation received for the performance of personal services are not taxable income or are offset by an equivalent deduction for the personal services rendered, including an argument that a taxpayer has a “claim of right” to exclude the cost or value of the taxpayer’s labor from income or that taxpayers have a basis in their labor equal to the fair market value of the wages they receive, or similar arguments described as frivolous in Rev. Rul. 2004-29, 2004-1 C.B. 627, or Rev. Rul. 2007-19, 2007-1 C.B. 843.

At the same time, of course, what a lame "silver bullet" this theory is, even were it not manifest nonsense! After all, even if the imagined loophole existed, Congress could change section 83 any time it caught on to its mistake.

THOSE PRESENTED WITH the "Section 83" nonsense should run, not walk, away. The actual truth about the tax is ready and waiting.