What Is an 83(b) Election?

Introduction

Congrats, you recently received a grant of restricted stock! In most cases, tech executives who receive such grants are taxed upon the shares vesting. Yet, this is not the only available choice. Some companies allow for accelerated taxation of the award. Managing the tax implications of receiving restricted stock can be challenging.

This article will discuss the importance of understanding the 83(b) election for minimizing taxes and making wise decisions with your equity compensation.

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What is an 83(b) election?

The fair market value of restricted stock is usually taxed upon vesting. If you would rather be taxed on the value at the grant date instead of the vesting date, then you would make an 83(b) election. The filing of the 83(b) election must be made within 30 days of the grant, otherwise it is not valid. If the filing is not made, the award will be taxed at vesting.

The 83(b) election is also available for early-exercise options in private companies, but is not available for restricted stock units (RSUs) or performance stock units (PSUs).

The 83(b) election is derived from Internal Revenue Code Section 83, which stipulates property derived from the performance of services. Under the meaning of IRC 83, restricted stock and early-exercise options are property.

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How Does the 83(b) Election Work?

Here is a hypothetical example. You are granted 3,000 shares of restricted stock at a price of $50. Your marginal federal income tax bracket is 32% and the long-term capital gains tax is 15%.

The fair market value (FMV) at grant is $150,000 (3,000 x $50). If making the 83(b) election at grant, your tax is $48,000 ($150,000 x 32%). The capital gains holding period now begins for subsequent sales.

Alternatively, if you do not choose the 83(b) election, you are instead taxed on the FMV of the restricted stock at vesting. If the stock price at vesting has climbed to $75, your tax is $72,000 [(3,000 x $75) x 32%]. 

You have decided to sell all 3,000 shares at $75. If you didn’t choose the 83(b) election, then you sell immediately at vesting. Your total tax is $72,000. 

If making the 83(b) election, you sell the stock after owning it for more than one year, which qualifies for long-term capital gains treatment, with a tax of 15%. The capital gains tax is $11,250 [($225,000 FMV - $150,000 Cost Basis) x 15%]. The total tax under this election is $59,250 ($48,000 + $11,250). Note how the election allowed you to turn $75,000 of stock price appreciation from ordinary income tax treatment into capital gains treatment.

In this hypothetical example, the 83(b) election provided tax savings of $12,750 ($72,000 - $59,250). 

Advantages of Filing an 83(b) Election

The main purpose for making the 83(b) election is that you believe the stock price will increase between the grant and vesting dates. If that happens, you will be taxed ordinary income on the lower FMV value at grant. And you start the capital gains clock earlier instead of waiting until the vesting date. The goal is to minimize your overall tax on the equity award.

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Risks and Drawbacks

There are drawbacks of the 83(b) election that you need to be mindful of:

The decision is irrevocable, except on or before the election due date (30 days after grant).

If you lose or leave your job prior to vesting, you forfeit the equity awards.

You need the cash upfront to pay taxes due. You cannot sell any shares because you don’t yet own the stock.

You cannot recover the taxes paid. There is no tax deduction or credit for taxes already paid.

The stock declines in price between the grant and vesting dates. So, you paid taxes earlier than you needed to and you paid a higher amount of tax than would have been paid upon vesting.

Opportunity cost – You paid taxes early, but that money could have been used for other purposes while you waited until the vesting date.

Higher ownership in the company stock, which may increase your concentration risk.

The pre-IPO company fails.

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Key Considerations Before Making an 83(b) Election

Financial position: The election accelerates the tax payment. Can you afford it? Also, if your awards are early exercise stock options, do you have cash available to buy the shares?

Company prospects and availability: How confident are you that your company will grow, and the stock price will increase? Does your company make available the 83(b) election?

Alternative Minimum Tax (AMT): This may apply in the case of early-exercise Incentive Stock Options (ISOs). If the FMV is higher than the exercise price, it may result in an AMT preference item for tax purposes.

Professional guidance: It is important to weigh your decisions with a professional, such as a financial planner and a CPA.

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Filing the 83(b) Election

In November 2024, the IRS created an official Form 15620 for filing an 83(b) election. Currently you are required to send the completed form via mail to your IRS office. The form is expected to be available for e-file in the future.

It is important to reiterate that the 83(b) election must be made within 30 days of the equity grant to be valid. Otherwise, the restricted stock award will be taxed upon vesting.

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Conclusion

Navigating equity compensation decisions can be challenging. Each circumstance is unique and carries potential tax implications. It is critical to know and understand your equity awards and the available choices. The 83(b) election may be appropriate in your situation to reduce your tax bill. And while there are many advantages to making the election, there are risks and drawbacks to consider. 

If you need help with your equity awards, TwoTen Planning can help.

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