What you need to know about Section 83(b) Elections.

What you need to know about Section 83(b) Elections.

Taxes, stock options, and you. Oh my.


What is the a Section 83(b) Election?

A Section 83(b) Election is a form that you send the Internal Revenue Service (IRS) notifying them that you'd like to be taxed on your equity (ex: shares of restricted stock) on the date the equity was granted to you, rather than on the date the equity vests. This form must be sent within 30 days of receiving ownership of the vested stock interest. 

Key Points: 

  • Section 83(b) Election only applies to stock that is subject to vesting - fully vested stock (i.e., stock that you get immediately) is taxed at the time of the grant. 
  • Section 83(b) Election must be made within 30 days after the grant of your restricted stock. 
  • The grant date of your restricted stock is the date the board approves the grant - even if you don't receive paperwork until later. 


A brief lesson on taxes

I bet you're wondering why you would want to change the date on which you're taxed on your equity. The answer is simple - there are different types of tax rates. The maximum ordinary income tax rate in 2014 was 39.6%, whereas the maximum long-term capital gains rate in 2014 was only 20%. 

The goal is to get as much as possible of your gain on the sale of your restricted stock taxed at the long-term capital gains rate (20%), rather than the ordinary income tax rate (maximum of 39.6%). 

Taxes on the initial grant of restricted stock

Assuming you paid nothing (or close to nothing) for your restricted stock, you will be taxed  at the applicable ordinary income tax rate on the value of your restricted stock as determined at the time of the grant (if a Section 83(b) Election is filed) or at vesting (if no Section 83(b) Election is filed). 

Taxes on the sale of restricted stock

When you later sell your stock, assuming it's been more than one year from the date of grant (if a Section 83(b) Election is filed) or more than one-year from the date of vesting (if no Section 83(b) Election is filed), then the additional gain will be taxed at the applicable long-term capital gains rate. 


Examples

In each of the below examples, assume the following: 

  • You receive 200,000 shares subject to vesting.
  • The shares are worth $.01 per share at the time of grant
  • The shares are worth $1.00 per share at the time of vesting. 
  • The shares are worth $5.00 per share when sold more than one year later. 
  • You are subject to the maximum ordinary income tax rate and long-term capital gains rate of 20%. 

Example 1 - 83(b) Election

In this example, you have timely filed a Section 83(b) Election within 30 days of the grant of registered stock, when your shares are worth $2,000. You pay the ordinary income tax of $792 (i.e., $2,000 x 39.6%). Because you filed a Section 83(b) Election, you do not have to pay any taxes when the stock vests, only when you sell the stock later. 

On the sale, one year later, you recognize a taxable gain of $4.99 per share (not $5.00, because you get credit for the $.01 per share that you already paid income tax on), and pay additional tax of $199,600  (i.e., $998,000 x 20%). Your economic gain after paying taxes? $799,608 (i.e., $1,000,000 minus $792 minus $199,600). 

Example 2 - No 83(b) Election

In this example, you did not file a Section 83(b) Election. Because of that choice, you will pay no tax at the grant of the stock because the shares are not vested. Instead, you will recognize income of $200,000 when the shares vest and thus have ordinary income tax of $79,200. 

On the sale, one year later, you recognize a taxable gain of $4.00 per share (not $5.00, because you get credit for the $1.00 per share you have already paid income tax on), and pay an additional tax of $160,000  (i.e., $800,000 x 20%). Your economic tax gain after paying taxes? $760,800  (i.e., $1,000,000 minus $79,200 minus $160,000). 

Results

In the above example, filing a Section 83(b) Election would have saved you $38,808. Additionally, filing the Section 83(b) Election has two other benefits. 

It would have prevented you from having $79,200 in owed taxes when the stock vests, which may have been during a time you did not have enough cash to pay the tax. 

It starts your long-term capital gains holding period clock earlier - which means that you can sell your stock sooner than you would without a Section 83(b) Election. 


Is it always best to file a Section 83(b) Election?

It virtually always makes sense to file a Section 83(b) Election when the restricted stock is worth a nominal amount (i.e., $.01). However, if you were to receive 200,000 shares of restricted stock worth $1.00 per share, this would immediately cause you tens of thousands of dollars worth of taxes. If the company were to subsequently fail before your stock vests, it likely would have been economically better to not have filed the Section 83(b) Election. 


Steps for filing a Section 83(b) Election

  • Send the original election form and cover letter to the IRS Center where you normally file your tax return. Do this within 30 days of the grant. 
    • The "date filed" is the date your letter is postmarked. 
    • Ask your tax advisor for the correct Internal Revenue Service Center address or you can also find it by searching for the term “where to file” on www.irs.gov or by calling 1-800-829-1040. 
  • We recommend sending this paperwork via certified mail, and requesting a return receipt. 
  • Deliver a copy of the completed election form to the company issuing the stock. 
  • Attach one copy of the completed election form to your federal personal income tax return (Form 1040) for the calendar year in which you received the stock, when you file it the subsequent year.
  • Attach one copy of the completed election form to your state personal income tax return for the calendar year in which you received the stock, when you file it the subsequent year (assuming your state requires state income tax).
  • Retain one copy of the completed election form for your personal permanent records and retain proof of mailing.


Section 83(b) Election for LLC

Section 83(b) Election for restricted stock issued by a LLC. 

Free Download

Section 83(b) Election for Corporation

Section 83(b) Election for restricted stock issued by a corporation.


Free Download

Do foreign entrepreneurs owning U.S. corporations need to fill an 83(b) election form?

Foreign entrepreneurs owning U.S. corporations only need to file a Section 83(b) Election if they have plans to move to the United States and become an individual taxpayer. 

If you do plan on moving to the United States, then you should fill out the Section 83(b) Election form. If you do not have a Social Security Number (SSN) or a Individual Taxpayer Identification Number (ITIN), then you should fill it with "awaiting ITIN" in the ITIN field.