Understanding the 83(b) Election: A Strategic Tax Decision

When property, such as employer stock, is transferred to a service provider with vesting requirements, there is no income recognition at the time of transfer. Instead, the service provider recognizes ordinary income equal to the fair market value of the property when it vests.

However, the 83(b) election offers an alternative approach that can be advantageous under certain circumstances.

What is an 83(b) election?

An 83(b) election allows a taxpayer to include the fair market value of the property in their income in the year it is granted, even if it is subject to vesting requirements. This can be beneficial if the property is expected to appreciate significantly over time. By making this election, any future appreciation after the initial election will be taxed as a capital gain rather than ordinary income.

Example

Consider a taxpayer who receives 10,000 shares of stock subject to a five-year vesting condition in Year 1, when the fair market value of the stock is $10 per share. On the vesting date in Year 5, the stock is valued at $50 per share:

• Without an 83(b) election — The $500,000 fair market value at vesting would be considered wages subject to ordinary income tax, federal income tax withholding, and employment taxes in Year 5.
• With an 83(b) election — The $100,000 fair market value at grant would be considered wages subject to ordinary income tax, federal income tax withholding, and employment taxes in Year 1.

Considerations and risks

While the 83(b) election can offer significant tax advantages, it also carries some risks. Taxpayers should carefully consider the likelihood of meeting the vesting conditions and the expected appreciation of the stock. If the stock is forfeited after the 83(b) election is filed because the vesting conditions are not met, there is no deduction for the amount previously included in income. Additionally, if the value of the property decreases between grant and vesting, the taxpayer may end up with more taxable income at an earlier time than under the general rule.

When is the 83(b) election available?

Section 83(b) elections are available for restricted property grants, such as grants of restricted stock. They are generally not available for grants of restricted stock units or stock option grants. Taxpayers must make this election within 30 days of the initial property transfer. Missing this strict deadline means waiting until the property vests to pay taxes on its value.

Filing the 83(b) election

To make an 83(b) election, taxpayers must file a written statement with the IRS at the office where they regularly file tax returns and send a copy to their employer. The election must include:

• The taxpayer's name, address, and identification number
• A description of the property subject to the election
• The date of the transfer and the calendar year involved
• The nature of the restrictions attached to the property
• The fair market value of the property
• The amount paid (if any) for the property
• A statement that copies of the election have been filed with the employer and, if necessary, with the transferee of the property

The IRS has recently introduced Form 15620, which taxpayers can use to make an 83(b) election. However, this form is not required, and taxpayers may continue to file a self-prepared signed statement.

Understanding the intricacies of the 83(b) election can help taxpayers make informed decisions about their equity compensation and potential tax liabilities. As always, consulting with a tax professional is recommended to effectively navigate these difficult decisions.

A big thank you to our National Tax Office for their assistance with this blog post!