Art wrote: ""So far everyone seems to have avoided the issue of not paying FICA/Medicare taxes on this income. If a CEO is paid a salary of $1 and restriceted stock of $1million, which is not uncommon in some situations, how does FICA/Medicare tax get collected? If poor Joe Taxpayer who owns a small S Corp or even C Corp tries to say he agreeed to work for only $1, how far would he get? Why does a CEO of a Firtune 500 get to take just a $1 salary? And how does FICA/Medicare get their cut?"" In the example you give, it would depend on how Sec. 83 applied to the restricted stock, either on the date of grant or at some later date when the restrictions lapse or the stock is otherwise sold. Under Sec. 83, the fair market value of property received as compensation for services performed, less any amount paid for such property, is included in the recipient's gross income for the first taxable year within which such property is transferable or not subject to a substantial risk of forfeiture. Once the restricted stock in your example is transferable or no longer subject to a substantial risk of forfeiture, the FMV of the stock at such time, less any amount paid, is gross income from the performance of services and, if the recipient was an "employee" for payroll tax purposes, is subject to FICA, FUTA and wage withholding. Further, if the recipient sells his interest therein in an arms' length transaction prior to the time his rights either become transferable or are no longer subject to a substantial risk of forfeiture, the same result applies as of the date of sale, in which case the sales proceeds are ordinary income rather than capital gain unless the recipient had made a Sec. 83(b) election at the time of initial receipt. If an 83(b) election is made, the FMV, less amounts paid, is included in income at the time of receipt notwithstanding restrictions on transfer or risks of forfeiture (of course, if the stock is then forfeited, there is no corresponding loss deduction to offset the income inclusion). As a result, if we assume that the CEO in your example received $1M worth of stock in Year 1 without having to pay anything to acquire the stock and that the CEO could not sell or otherwise transfer, and that was subject to forfeiture, until Year 4, and if we further assume that the stock has the same FMV of $1M in Year 4, then the CEO would have no income from the stock grant in Year 1 (unless he made a Sec. 83(b) election - most such recipients do). In Year 4, when the stock is both transferable and no longer subject to a substantial risk of forfeiture, the CEO would have $1M in gross income (again, assuming no 83(b) election) which would most likely constitute "wages" for FICA, FUTA and income tax withholding purposes. The CEO's employer would therefore be required to withhold and pay over to Uncle Sugar the FICA, FUTA and income tax withholding amounts attributable to that stock in Year 4. In addition, the employer company would not get a deduction for compensation paid until Year 4. To see some of the other variations, take the following further assumptions to your example: Assume that CEO receives the stock in Year 1 and that, under Sec. 83, the stock is not includable in his income until Year 4, at which time the stock is worth either (a) $2M, or (b) $500k. If CEO does not make a Sec. 83(b) election, then the following occurs: Under alternative (a), above, CEO includes $2M in income as ordinary income in Year 4. Company takes a deduction in Year 4 for compensation paid of $2M (provided that the rules on excessive compensation do not limit the deduction to $1M) and withholds FICA, FUTA and income tax on the $2M (typically, since the CEO is not going to give the money back, the employee withholding amounts would otherwise come out of other amounts the company owes the CEO or, if none exist, the withheld amounts paid by the company out of its own pockets will constitute additional income to the CEO
- i.e., the $2M gets grossed up). Under alternative (b), without an 83(b) election, the CEO recognizes $500k of gross income in Year 4 and the company takes a deduction of $500k for compensation paid in Year 4 and withholds (or pays, with a gross up to the CEO) FICA, FUTA and income tax withholding on that amount. If, instead, the CEO makes a valid 83(b) election in Year 1, the following results occur: Under alternative (a), CEO recognizes $1M of gross ordinary income in Year 1 and the company takes a $1M deduction for compensation paid. The company also withholds (or pays, with a gross up) FICA, FUTA and income tax withholding on $1M. In Year 4, when the restrictions on transferability and the risk of forfeiture lapse, the CEO has no further compensation income. In addition, if the CEO then sells the stock for $2M, he has a long-term capital gain of $1M ($2M proceeds, less his basis of $1M - the amount of compensation income recognized on the stock, plus any amounts paid, are the CEO's basis in the stock). Under alternative (b), the same results as above hold in Year 1 and, as a result, CEO takes the stock with a basis of $1M. When CEO sells for $500k in Year 4, he will recognize a long-term capital loss of $500k. Further, if CEO makes an 83(b) election in Year 1, he recognizes $1M of compensation income. However, if he subsequently forfeits the stock in Year 3, he will not get a deduction for that loss. It should be noted that, provided that a pay package consisting of $1 cash and $1M in restricted stock constitutes reasonable compensation for executives of this sort, even if the CEO is the sole shareholder of the corporation and received substantial dividend-type distributions from the corporation on account of his stock, the Service is not likely to assert that the corporation paid inadequate compensation to the CEO and attempt to reclassify the dividend-type distributions as disguised compensation. With respect to poor Joe Taxpayer who owns his own little C corp, if he can show that it was a reasonable business decision to work for only $1 of compensation (e.g., because the corp was a start-up without any current cash income, but with the potential to become quite valuable in later years, thereby increasing the value of Joe's stock), then he may very well be able to sustain his reporting position in the face of an IRS challenge. The problem doesn't typically arise in the context of start-ups or corporations that are cash-poor, but with corporations (C or S) that are doing well, have sufficient cash, and are either retaining cash well in excess of the needs for working capital or are making substantial dividend distributions out to their shareholders. In those instances, unless Joe Taxpayer is being adequately compensated in some manner (e.g., with property the income from which is deferred under Sec. 83 and not accelerated under Sec. 409A), the IRS will often seek to recharacterize dividends received by Joe as disguised compensation income, on the theory that no-one in an arms' length transaction would agree to work for a well-off corporation for nothing, and that therefore at least a portion of the dividend distribution really constitutes remuneration for services performed. In other words, substance over form.