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Private company A was bough by a public company B. All unvested A's common stock (result of early exercise) will be rolled into B's restricted stock (with the same vest schedule).

Is this taxable event at the time when deal closes? If yes, then is this taxable as Cap gain or Ordinary Income?

Now lets assume that at the vest date the company's B stock price increases (or decreases). How this is going to be taxed?

I am asking for public opinion, because I received contradictory information from two different tax advisors:

  1. One told me that I should not care about taxes until I receive cash (conversion is not taxable event),
  2. Other says that spread from acquisition is taxable as Cap gain (conversion is taxable event).

The closest law, that seemed to explain this situation was (26 USC § 1033). But again, I could be missing something... I am leaning towards the second tax advisor opinion.

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I don't think its a taxable event since no income has been constructively received (talking about the RSU shareholders here). I believe you're right with the IRC 1033, and the basis of the RSU is the basis of the original stock option (probably zero). Edit: see below.

However, once the stock becomes vested - then it is a taxable event (not when the cash is received, but when the chance of forfeiture diminishes, even if the employee doesn't sell the stock), and is an ordinary income, not capital.

That is my understanding of the situation, do not consider it as a tax advice in any way.

I gave it a bit more though and I don't think IRC 1033 is relevant. You're not doing any exchange or conversion here, because you didn't have anything to convert to begin with, and don't have anything after the "conversion". Your ISO's are forfeited and no longer available, basically - you treat them as you've never had them. What happened is that you've received RSU's, and you treat them as a regular RSU grant, based on its vesting schedule.

The tax consequences are exactly as I described in my original response: you recognize ordinary income on the vested stocks, as they vest. Your basis is zero (i.e.: the whole FMV of the stock at the time of vesting is your ordinary income). It should also be reflected in your W2 accordingly.

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  • BTW: remembering your earlier question, you can check if you can use 83(b) on the RSU's in your case after the conversion.
    – littleadv
    Aug 17, 2012 at 23:07
  • If 83(b) is possible after conversion, I guess it would be risky. Because I do not expect B's FMV stock price to go dramatically up.
    – user4910112
    Aug 17, 2012 at 23:21
  • Well, that's another thing to consider:) With a regular RSU of an established company I wouldn't advise 83(b). Its good for startups where the appreciation is big and rapid.
    – littleadv
    Aug 17, 2012 at 23:23
  • Anyway getting back to the 83(b), I could have elected 83(b) tax treatment for A common stock and also for B restricted stock. If I would have done it for A, then would it be automatically inherited also for B stock? How would that work...
    – user4910112
    Aug 17, 2012 at 23:49
  • That would probably make the difference between your 83(b) basis in A ISO and the basis in the new RSU to be capital gain instead of ordinary gain. But I'm not sure, never actually researched that.
    – littleadv
    Aug 17, 2012 at 23:52

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