Understanding 83(b) Elections: A Guide for Employees with Equity Compensation

What is an 83(b) Election?

An 83(b) election is a formal statement to the IRS declaring your choice to pay taxes on the total fair market value of restricted stock or equity at the time of grant rather than at the time of vesting. This election can have significant tax implications for employees receiving equity compensation, particularly in startups where the company's value may increase substantially over time.

Key Benefits of Filing an 83(b) Election

• Potential Tax Savings: By paying taxes on the fair market value of equity when granted (typically lower) rather than when vested (potentially much higher), you may significantly reduce your overall tax burden. This is especially beneficial in high-growth companies where equity value increases substantially.
• Start of Capital Gains Period: Filing an 83(b) election starts your capital gains holding period immediately, rather than at each vesting date. This means you may qualify for long-term capital gains rates sooner when you eventually sell your shares.

Real-World Example

Let's consider a typical scenario: You join a startup and receive 10,000 shares of restricted stock with the following details:

• Grant date fair market value: $1 per share
• 4-year vesting schedule with a 1-year cliff
• Projected value at vesting: $5 per share

Scenario A: Without 83(b) Election

• Year 1 (2,500 shares vest): Pay taxes on $12,500 (2,500 × $5)
• Year 2 (2,500 shares vest): Pay taxes on $12,500 (2,500 × $5)
• Year 3 (2,500 shares vest): Pay taxes on $12,500 (2,500 × $5)
• Year 4 (2,500 shares vest): Pay taxes on $12,500 (2,500 × $5)

Total taxable income: $50,000

Scenario B: With 83(b) Election

• At grant: Pay taxes on $10,000 (10,000 × $1)
• At vesting: No additional taxes

Total taxable income: $10,000

Important Considerations

Filing Requirements

• Must file within 30 days of receiving equity grant
• Submit three copies of the election:
  • One to the IRS
  • One to your employer
  • One for your personal records
• Send via certified mail with return receipt for proof of filing

Risk Factors

• Forfeiture Risk: If you leave before vesting, you don't get a refund of taxes paid
• Value Decline: If the company's value decreases, you've paid taxes on a higher amount
• Cash Requirements: Must have cash available to pay taxes upfront

When to Consider an 83(b) Election

An 83(b) election might be appropriate if:

• You believe the company's value will increase significantly
• The current fair market value is low
• You plan to stay through the vesting period
• You can afford the upfront tax payment
• Your equity has substantial vesting remaining

When to Skip an 83(b) Election

You might want to skip the election if:

• The company's value is already high
• You're uncertain about staying through vesting
• You can't afford the upfront tax payment
• There's significant risk of company failure

Steps to File an 83(b) Election

Prepare the Election Document

• Include personal information
• Describe the property (shares received)
• State the fair market value
• Indicate amount paid (if any)
• Include date of transfer

Submit the Election

• Mail to IRS Service Center where you file taxes
• Send within 30 days of grant (no exceptions)
• Keep proof of mailing

Notify Your Employer

• Provide a copy to your company
• Keep documentation of submission

Tax Reporting Requirements

Year of Grant

• Report the fair market value minus any amount paid
• Include as income on your tax return
• Keep records of the election and proof of filing

Future Years

• No additional tax at vesting
• Report capital gains/losses upon sale

Common Mistakes to Avoid

• Missing the 30-day deadline
• Incorrect valuation of shares
• Not keeping proper documentation
• Not informing your employer
• Not considering alternative tax scenarios

The 83(b) election can be a powerful tax planning tool for employees receiving equity compensation. While it carries some risks, the potential benefits can be substantial in the right circumstances. Always consult with a tax professional to understand the implications for your specific situation.