83(b) Elections — from The Holloway Guide to Equity Compensation

The following excerpt is from The Holloway Guide to Equity Compensation, a detailed reference with hundreds of resources on stock options, RSUs, job offers, taxes, and more. You can read more from this excerpt, or access the full guide text here.

THE FULL VERSION OF THIS GUIDE ANSWERS QUESTIONS LIKE:

Do incentive stock options qualify for 83(b)?

What is an 83(b) election?

Can the 83(b) election be filed late?

How do 83(b) elections work?

This section covers one of the most important and complex decisions you may need to make regarding stock awards and stock options: paying taxes early with an 83(b) election.

• If the stock is in a startup with low value, this may not result in high tax. If it’s been years since the stock was first granted and the company is now worth a lot, the taxes owed could be quite significant.
• Generally, restricted stock is taxed as ordinary income when it vests.

Section 83(b) of the Internal Revenue Code offers taxpayers receiving equity in exchange for work the option to pay taxes on their options before they vest.

If qualified, individuals can tell the IRS they prefer this alternative in a process called an 83(b) election. Paying taxes early with an 83(b) election can potentially reduce taxes (sometimes significantly). If the shares go up in value, the taxes owed at vesting might be far greater than the taxes owed at the time of receipt. Why is it called an election? Because you are electing (choosing) to pay taxes early in exchange for this treatment by the IRS.

An 83(b) election isn’t guaranteed to reduce your taxes. For example, the value of the stock may not increase. And if you leave the company before you vest, you don’t get back the taxes you’ve already paid.

Other notes about filing an election:

• Founders and very early employees will almost always want to do an 83(b) election upon the receipt of unvested shares, since the stock value is probably low. If the value is really low, and the taxes owed are not that great, you can make the election without having to pay much tax and start your capital gains holding period on the shares.
• If you receive an early exercisable stock option (when you don’t have to wait for the the stock to vest), you can make an 83(b) election upon receipt of the exercised shares.
• You must file the 83(b) election yourself with the IRS within 30 days of the grant or exercise, or the opportunity is irrevocably lost.
• Note an 83(b) election is made on receipt of actual shares of stock. Technically, it cannot be made on the receipt of a stock option itself: You first must exercise that option, then file the election.
• Section 83(b) elections do not apply to vested shares; the election only applies to stock that is not yet vested. Thus, if you receive options that are not early exercisable (meaning you have to wait until they vest to exercise), an 83(b) election would not apply.

With the passing of Tax Cuts and Jobs Act (TCJA) in 2017, Congress approved a new Section 83(i) that is intended to allow deferral of tax until RSU and stock option holders can sell shares to pay the tax bill. It is still unclear whether companies will choose or be able to make this available to employees.