The 83(b) Election

The Section 83(b) election is a provision under the U.S. tax code that allows you to be taxed on the fair market value of stock that is subject to vesting, such as restricted stock, at the time of grant instead of when the stock vests. This election accelerates the ordinary income tax liability and can be advantageous in situations where the market value of the stock is expected to rise significantly between the time of grant and vesting.

 

When employees are granted stock or options in a company, particularly in the case of startups, these grants are often subject to a vesting schedule.  As a result, employees do not own the stock or options until a specified amount of time has passed.

Assuming you received the restricted stock as compensation and did not purchase it, you will be taxed at the ordinary income tax rate on the market value of your restricted stock at grant (if a Section 83(b) election is filed) or at vesting (if no Section 83(b) election is filed).  In the case of stock options, the bargain element (the difference between the strike price and the market price) may be subject to ordinary income tax or alternative minimum tax.  When you later sell your stock, any additional gain will be taxed at the applicable capital gains tax rate.

 

How to Make the Section 83(b) Election:

 

• Timing: The 83(b) election must be filed with the IRS within 30 days of the grant date.  Failure to file within that time will render the election void.

• Procedure:

  1. Write a letter to the IRS stating the desire to make the 83(b) election.

  2. Include specific details such as taxpayer and company information, grant date, number of shares, fair market value, and amount paid for the stock.

  3. File the election letter with the same IRS office where you file your annual tax return.

  4. Send a copy of the 83(b) election to the company that granted the stock.

  5. Keep a copy of the filed election and proof of mailing (like certified mail receipt) for your records.

• Tax Reporting: After making the 83(b) election, report the amount of income from the stock grant on your tax return for that year.

 

Financial Planning and Tax Considerations:

 

• Upside Potential: If you believe your company stock's value will rise significantly over the vesting period, making the 83(b) election can lock in a lower taxable amount and could save substantial taxes in the long run.

• Downside Risk: If you make the 83(b) election and then forfeit the stock (e.g., by leaving the company before it vests), you will not get a refund on the taxes you paid.  Also, if the stock's value declines, you will have paid taxes on a higher valuation.

• Liquidity Concerns: By making the 83(b) election, you will owe taxes right away on the grant, even if the stock has not vested. Ensure you have the liquidity to pay this tax bill.

• Long-Term Capital Gains: Making the 83(b) election starts the clock on long-term capital gains treatment. Once you have held the stock for a year or more, any appreciation in value could qualify for the more favorable long-term capital gains tax rate.

• AMT Considerations: For those receiving Incentive Stock Options (ISOs), making the 83(b) election might have implications for the Alternative Minimum Tax (AMT).  Always consult with a tax professional to understand these nuances.

• Record Keeping: It is crucial to keep thorough records of your 83(b) election, including the filing itself, proof of mailing, and any correspondence with the IRS or the company.

 

Conclusion

 

Whether or not to make a Section 83(b) election is a personal decision that should be made on a case-by-case basis, taking into consideration your individual tax and financial situation.  Employees of high-growth, early-stage companies may want to make an 83(b) election if the strike price of their stock options is below the fair market value of the stock.  Also, high-income individuals may want to make an 83(b) election to spread out their income tax liability over multiple years.  We recommend consulting professional financial planning and tax advisors with regards to this complex tax provision.  If you need help finding one, do not hesitate to reach out.  We are here to help you find a trusted financial advisor that is right for you.