What Is an 83(b) Election?
An 83(b) election is a provision under U.S. taxation law, specifically within the Internal Revenue Code, that allows individuals receiving unvested restricted stock as equity compensation to pay taxes on the fair market value of the stock at the time of its grant, rather than when it vests. Typically, taxable income from equity compensation is recognized when the shares are no longer subject to a vesting period or become transferable. The 83(b) election allows for an acceleration of this tax event, potentially converting future appreciation from ordinary income to capital gains upon eventual sale, which can result in a lower overall tax liability if the stock appreciates significantly.
History and Origin
Section 83 of the Internal Revenue Code governs the taxation of property transferred in connection with the performance of services. Prior to the existence of Section 83(b), individuals receiving restricted property, such as company stock, would typically recognize income only when the property vested and was no longer subject to a "substantial risk of forfeiture". This meant that if the stock appreciated substantially between the grant date and the vesting date, the entire appreciation would be taxed as ordinary income. The Internal Revenue Code of 1986, which is the domestic portion of federal statutory tax law in the United States, includes Section 83, providing the framework for how such property is taxed. Section 83(b) was introduced to offer an alternative tax treatment, allowing recipients to elect to be taxed at the time of the grant, essentially "pre-paying" taxes on the initial value and benefiting from capital gains treatment on future appreciation.
Key Takeaways
- An 83(b) election allows recipients of restricted stock to pay taxes on the stock's fair market value at the time of the grant, rather than when it vests.
- The election must be filed with the Internal Revenue Service (IRS) within 30 days of the stock's transfer date.
- It can potentially reduce an individual's overall tax burden if the stock is expected to appreciate significantly between the grant date and the vesting date.
- Future appreciation after an 83(b) election is generally taxed at typically lower capital gains rates when the shares are sold, rather than at ordinary income rates.
- Risks include paying taxes on stock that may later decline in value or be forfeited, as the election is generally irrevocable without IRS consent.
Interpreting the 83(b) Election
An 83(b) election is a strategic decision for individuals receiving restricted stock and should be considered in the context of their personal financial situation and expectations for the company's future value. When an individual makes this election, they are choosing to include the current fair market value of the unvested property in their gross income immediately22. This action sets the cost basis for the shares at this initial, often lower, value. Any subsequent increase in the stock's value between the grant date and the eventual sale date would then be treated as a capital gain, potentially qualifying for favorable long-term capital gains tax rates if held for over a year from the grant date20, 21. Conversely, without an 83(b) election, the income recognized at vesting would be based on the stock's value at that time, which could be substantially higher, and taxed as ordinary income19.
Hypothetical Example
Consider Sarah, an employee at a startup, who receives a grant of 10,000 shares of restricted stock on January 1, 2025. The shares have a nominal fair market value of $0.05 per share at the grant date, making the total value $500. These shares are subject to a four-year vesting period.
Scenario 1: Sarah makes an 83(b) election.
Within 30 days of January 1, 2025, Sarah files her 83(b) election with the IRS. She reports $500 ($0.05 x 10,000 shares) as taxable income for 2025, subject to ordinary income tax rates. Four years later, on January 1, 2029, the shares fully vest, and the company's stock is now worth $5.00 per share. At this point, no additional ordinary income is recognized upon vesting due to the 83(b) election. If Sarah decides to sell her shares when they are worth $5.00 each, her capital gain would be calculated based on the difference between the sale price ($5.00) and her initial cost basis ($0.05). The appreciation of $4.95 per share ($49,500 total) would be taxed at long-term capital gains rates.
Scenario 2: Sarah does NOT make an 83(b) election.
Sarah does not file the 83(b) election. When her shares fully vest on January 1, 2029, and the stock is worth $5.00 per share, she recognizes $50,000 ($5.00 x 10,000 shares) as ordinary income for 2029. This amount is subject to her marginal income tax rate. If she then sells the shares, any further appreciation beyond $5.00 would be a capital gain. In this scenario, a much larger amount of income is taxed at ordinary rates.
This example illustrates how the 83(b) election can lead to significant tax savings if the stock's value is expected to grow substantially.
Practical Applications
The 83(b) election is primarily relevant in the context of equity compensation, particularly for employees, founders, and consultants of early-stage companies and startups that grant restricted stock. These companies often grant stock when its fair market value is low, or even negligible, offering a strategic advantage to accelerate the tax event.
For recipients, the practical application centers on minimizing future tax liability and optimizing the tax treatment of their equity. By making an 83(b) election, individuals can lock in a lower taxable income at the grant date, shifting potential future appreciation to be taxed at capital gains rates rather than ordinary income rates18. This can be particularly beneficial if the company experiences rapid growth and its stock value increases significantly over the vesting period.
Companies also have considerations related to 83(b) elections. While the election is made by the individual, the company generally receives a corresponding tax deduction when the income is recognized by the service provider17. Additionally, public companies must adhere to U.S. Securities and Exchange Commission (SEC) disclosure requirements regarding executive compensation, which includes how stock-based awards are granted and accounted for, though 83(b) itself is an IRS matter16.
The election process requires careful attention to deadlines: the 83(b) election form must be postmarked and mailed to the appropriate IRS office within 30 days of the date the property is transferred14, 15. The IRS now provides Form 15620 for making these elections, though individuals can still file a written statement12, 13.
Limitations and Criticisms
While an 83(b) election offers potential tax advantages, it comes with notable limitations and risks. One significant drawback is its irrevocability. Once filed, an 83(b) election generally cannot be revoked without the consent of the IRS11. This means if the company's stock value declines after the election is made, or if the individual's shares are subject to forfeiture (e.g., due to leaving the company before the vesting period is complete), the individual may have paid taxes on income that was never realized or on shares that were never received9, 10. The IRS does not provide a deduction or refund for the amount previously included in income if the shares are forfeited8.
Another criticism relates to the upfront cash required for the tax payment. Even if the fair market value at the grant date is relatively low, it still constitutes taxable income for which the recipient must pay taxes out-of-pocket, as the shares are unvested and cannot be sold to cover the tax bill7. This can create a liquidity challenge, particularly for employees of early-stage startups who may have limited disposable income.
Furthermore, the benefits of an 83(b) election are contingent on the stock's future appreciation. If the stock does not increase in value or decreases by the time of vesting or sale, the election may have resulted in needlessly accelerated tax payments without any corresponding tax benefit6. It also assumes that capital gains rates will remain lower than ordinary income rates, which is typically the case but can change with tax law amendments.
83(b) Election vs. Restricted Stock Units
The 83(b) election applies specifically to restricted stock, not to Restricted Stock Units (RSUs) or most stock options. This distinction is crucial for understanding the differing tax treatments of various forms of equity compensation.
| Feature | 83(b) Election (for Restricted Stock) | Restricted Stock Units (RSUs) |
|---|---|---|
| Applicability | Available for actual stock (property) that is granted but unvested, subject to a substantial risk of forfeiture. | Represents a promise to deliver company stock or its cash equivalent at a future date (vesting). No actual property is transferred at grant. |
| Tax Event Timing | Elects to pay tax on fair market value at grant date. | Taxed as ordinary income at the time of vesting. |
| Capital Gains | Future appreciation after the election is taxed as capital gains upon sale. | Entire vested value taxed as ordinary income; only appreciation after vesting is capital gain upon sale. |
| IRS Filing | Requires an affirmative election (Form 15620 or written statement) with the IRS within 30 days of the grant. | No 83(b) election is possible or required for RSUs. |
| Cash Outlay | May require upfront tax payment on the grant date value. | Tax due only upon vesting, typically covered by withholding shares. |
The key difference lies in the nature of the grant. With restricted stock, the individual technically owns the shares from the grant date, albeit with restrictions. This ownership allows for the 83(b) election. RSUs, conversely, are merely a promise of future shares; no property is actually transferred until they vest, making an 83(b) election inapplicable5.
FAQs
Q1: Who should consider making an 83(b) election?
Individuals who receive restricted stock from a company, particularly a startup or private company, where the current fair market value of the stock is low but is expected to appreciate significantly, should consider an 83(b) election. It is especially relevant for founders and early employees who receive shares at a very low initial valuation.
Q2: What happens if I miss the 30-day deadline for an 83(b) election?
If the 30-day deadline is missed, you cannot make an 83(b) election for that specific grant of restricted stock4. The general tax rules under Section 83(a) will apply, meaning you will recognize ordinary income based on the stock's fair market value at the time it vests or becomes transferable. This can lead to a much higher tax liability if the stock has appreciated.
Q3: Can an 83(b) election be revoked?
Generally, an 83(b) election is irrevocable once filed without the consent of the IRS3. This means that if the stock's value decreases significantly or if the shares are forfeited (e.g., if you leave the company before vesting), you will not receive a refund for the taxes already paid on the initial value of the stock2.
Q4: Does an 83(b) election apply to all types of equity compensation?
No, an 83(b) election primarily applies to restricted stock or other property transferred in connection with services that is subject to a substantial risk of forfeiture and is not yet transferable1. It generally does not apply to Restricted Stock Units (RSUs), Incentive Stock Options, or nonqualified stock options (NQSOs), as these forms of equity compensation are taxed under different rules or at different times, or do not involve the immediate transfer of property.