Warrants are addressed by the IRS.
Banks and tax equity investors sometimes ask for warrants in a project developer in exchange for financing one or more of its projects. The warrants entitle the bank or tax equity investor to buy shares in the developer for a period of time at an agreed price.
The IRS addressed the tax consequences of warrants in a private letter ruling that the agency released in March. The ruling is Private Letter Ruling 201610006.
The company that asked for the ruling is a US corporation that buys products from suppliers and resells them. It entered into a contract with a foreign supplier and granted warrants to the two owners of the foreign supplier giving them the right to buy shares in the US corporation at an agreed price that was above the current share price. Exercise of the warrants was contingent on performance of the supply contract by the foreign supplier: the warrants could be cancelled if the foreign supplier failed to perform.
Anyone receiving warrants for providing services must report the value of the warrants as additional compensation. The question is when.
If the warrants have no readily ascertainable value when granted, then they are not reported immediately as income. The value is also not reported until the warrants vest, meaning that the holder is free to transfer them and they are not subject to a substantial risk of forfeiture. If the holder has not already been taxed on them, then he is taxed when he exercises the warrants or sells them to someone else. His income is the difference between the market price of the shares and the discounted price at which he was allowed to purchase them.
The company granting the warrants is usually allowed to deduct the same amount in the same year the holder reports income.
Some companies receiving warrants make an election under section 83(b) of the US tax code to report the value as income immediately upon receipt of the warrants without waiting until the warrants vest or are exercised in situations where the warrants have little value initially. When such an election is made, there is no need to report further income when the warrants vest or are exercised. The deduction for the company granting the warrants must match the amount and timing of the income, so there may be no deduction.