September 01, 2012 | By Keith Martin in Washington, DC

Developers who receive interests in projects in exchange for ongoing services should consider making a section 83(b) election to pay taxes on the interest upon receipt rather than waiting for it to vest fully.

Most power projects in the United States are owned by limited liability companies that are treated as partnerships for US tax purposes.

There are two kinds of partnership interests. A developer could receive an interest solely in partnership profits, or it could receive a capital interest that entitles the developer to a share of the asset value when the partnership liquidates. A developer receiving a capital interest in exchange for services must report the value as income after subtracting anything the developer had to pay for the interest. The interest is compensation for the services.

However, value does not have to be reported until there is nothing else he must do to earn it or, if earlier, when the developer first has a right to transfer the interest. The IRS allows the developer to choose to pay taxes upon receipt instead. This might make sense if the interest has a low current value but the value is expected to increase over time — for example, as construction of the project is completed. The developer can do this by filing a section 83(b) election with the IRS within 30 days after receipt of the interest.

The IRS released sample language for making such elections in late June. The language is in Revenue Procedure 2012-29. The election can only be made for interests that have a readily ascertainable market value.

The downside is that if the developer ends up reporting the value of an interest that never vests — for example, because the developer failed to do the full work required to earn it — then he has a capital loss, but only for any amount he paid for the interest and not for the full income he had to report.

Keith Martin