Corporate & Securities Blog

The 83(b) Election: How Founders, Employees and Service Providers Can Lower Their Tax Burden

By: Katrina Berishaj and Jeremy Gottlieb

Restricted stock awards are generally taxed when they vest, which can often occur months or years after such awards are granted. Stock options are generally taxed at exercise after they have vested (for incentive stock options, the spread between strike price and fair market value at exercise is a tax adjustment item for purposes of alternative minimum tax) and at a subsequent disposition. However, in certain instances, an option holder may purchase stock that is not vested. These awards are sometimes referred to as early exercise options.

Section 83(b) of the U.S. Internal Revenue Code (IRC) provides taxpayers the ability to elect to pay taxes on the fair market value (FMV) of restricted property at the time the property is granted as opposed to when the property is vested, effectively accelerating the recognition of ordinary income tax. The 83(b) election can be a powerful tax-savings tool, particularly for startup companies, where the value of the stock may be de minimis at the time of grant but is expected to increase over time.

Benefits of an 83(b) Election

Tax Savings at the Time of Issuance: An 83(b) election allows a taxpayer who is granted an equity award to pay income tax on the award at the time it is granted instead of waiting for the award to vest. Because the FMV of the shares is typically de minimis in a startup’s earliest stages, the taxpayer generally can pay the small amount of applicable taxes (if any) associated with the grant rather than paying taxes on the value of the stock at the time of vesting, when the FMV of the stock is potentially higher. Thus, where the value of stock increases over time, an 83(b) election can result in significant tax savings.

Capital Gains Treatment: Filing an 83(b) election starts the taxpayer’s capital gains holding period clock earlier. A taxpayer who makes the 83(b) election will receive the long-term capital gains rate if the sale of the shares occurs more than one year after the date of grant (or exercise date for early exercise options) rather than one year after vesting.

Potential Drawbacks of an 83(b) Election

One potential drawback of making an 83(b) election is that if the taxpayer later forfeits the shares before the shares vest, the taxpayer is not entitled to a refund for the taxes paid. Thus, there is the potential for a taxpayer to be out of pocket for the amount of taxes paid on stock that the taxpayer never owns.

Additionally, if the shares depreciate between the date of grant and the date they vest, a taxpayer who makes an 83(b) election will pay a higher tax by making the election.

How to File an 83(b) Election

To make a valid 83(b) election, the taxpayer must sign and complete the required election forms and return the forms to the IRS no later than 30 days after the date that the stock award is granted. For restricted stock, the grant date is typically the effective date of the agreement. In the case of early exercise options, it is the date on which the option holder exercises his or her options early (before the options vest). Failure to file within the timeframe will render the election void, and a taxpayer may recognize ordinary taxable income as vesting restrictions lapse.

In general, the taxpayer will need to provide the following information on the 83(b) election form:

  • Taxpayer’s general information.
  • A description of the property, including the quantity of shares of the issuer/company.
  • The date of grant.
  • The taxable year for which the election is being made.
  • The nature of restriction or restrictions to which the property is subject.
  • The FMV of the shares of the company on the date granted.
  • The amount, if any, paid for the property.
  • The amount to include in gross income.

The taxpayer must file the form with the IRS office that the taxpayer files his or her annual income tax return. A copy of the form should also be provided to the issuer/company. The taxpayer should retain a copy of the completed election form for his or her personal records.

Meet the Authors

Katrina Berishaj

Katrina Berishaj advises financial services clients, including banks, trust companies, broker-dealers, investment advisers, insurance companies and institutional investors, on issues arising under the fiduciary and prohibited transaction rules of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code, with respect to financial products, services and transactions. She assists corporate and governmental retirement plan sponsors on a broad range of issues concerning their fiduciary and non-fiduciary responsibilities. Katrina also advises on qualified and nonqualified retirement plans and executive and equity compensation arrangements. | 202.507.5179

Jeremy Gottlieb

Jeremy Gottlieb concentrates his practice on a wide variety of investment management-related matters, including counseling investment advisers and registered investment companies on legal, regulatory and transactional matters. | 215.564.8123

Share this Post:



Our Authors

© 2024 Stradley Ronon Stevens & Young, LLP. All rights reserved. | Site Design by Dynamic Wave Consulting

The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

Stradley Ronon is a registered service mark of Stradley Ronon Stevens & Young, LLP.
Review our privacy policy and disclaimer.