The 83(b) election is a specific choice under U.S. tax law that can significantly impact how you pay taxes on restricted stock or similar equity compensation. Generally, restricted stock granted by a startup or employer vests over time, and you owe ordinary income tax as the shares vest based on their then-current value. With the 83(b) election, you opt to pay tax upfront on the stock’s value at the grant date rather than at each vesting event.
This election can reduce your overall tax bill if your stock appreciates over time, because once you have paid taxes at grant, future gains are subject to capital gains tax rates—usually lower than ordinary income rates—when you eventually sell the shares. However, you take on the risk of paying tax on stock that might never vest or could lose value.
How It Works: Consider you receive 10,000 shares worth $1 per share with a four-year vesting schedule. Without the 83(b) election, you pay tax on the value of the shares as they vest annually, potentially at higher values, leading to more tax owed. By filing the 83(b) election within 30 days of the grant, you pay income tax on the full $10,000 immediately. If the shares increase in value to $20 each by the time they fully vest, you pay capital gains tax on the $190,000 gain ($200,000 sale price minus $10,000 tax basis).
Eligibility: Any individual receiving restricted stock or other property subject to vesting or restrictions may choose to file the 83(b) election. This typically includes startup founders, employees, and contractors.
Key Considerations:
- Timing: The election must be filed within 30 days of the stock grant date. This deadline is strict with no extensions.
- Risk: If the stock decreases in value or you forfeit your shares, the tax paid upfront is nonrefundable.
- Coordination: Informing your employer and retaining proof of filing is crucial.
- Tax Planning: Consulting a tax professional is advisable to weigh risks based on your expected stock performance.
Common Pitfalls:
- Missing the 30-day filing deadline means you cannot make the election.
- Paying tax upfront can create a cash flow challenge.
- Confusion exists between the 83(b) election and stock options; it only applies to restricted stock, not typical stock options.
Summary Table:
| Aspect | 83(b) Election | Default Tax Treatment |
|---|---|---|
| Tax Payment Timing | Pay on grant date | Pay as shares vest |
| Taxable Amount | Fair market value at grant | Value at each vesting date |
| Tax Rates on Gains | Ordinary income on grant value; future gain as capital gains | Ordinary income on vesting value |
| Risk | Pay tax on unvested stock that may lose value | Pay tax only on vested shares |
| IRS Filing | Mandatory within 30 days of grant | Not required |
For more detailed official guidance, refer to IRS Section 83(b).
Understanding the 83(b) election is essential for anyone granted restricted stock as part of compensation. It can offer substantial tax advantages if your stock appreciates, but it requires careful consideration and timely action. Planning ahead with a qualified tax advisor can help you make the best decision for your financial future.