An 83(b) election is a provision under the US Internal Revenue Code that allows an individual to pay taxes on the total fair market value of restricted stock at the time of granting rather than the time of vesting. This provision changes the timing of tax assessment for stock ownership or equity compensation granted by an employer.

When a person receives equity in a company that is subject to a vesting period, they typically owe taxes on the shares as the shares vest. But with an 83(b) election, the individual can choose to pay taxes on the full value of the equity up front, based on the value at the time of the grant. This can benefit the individual if they expect the value of the equity to increase over time, as the taxes they pay at the grant date could be substantially lower than the taxes they would pay later, as the shares vest at potentially higher valuations.

Below, we’ll explain how to file an 83(b) tax election, as well as the tax effects and potential benefits and risks. Here’s what you should know.

What’s in this article?

• Benefits of 83(b) elections
  
• Risks associated with 83(b) elections
  
• Tax effects of 83(b) elections
  
• What is the 30-day deadline for 83(b) elections?
  
• What happens if you choose not to file an 83(b)?
  
• How to file an 83(b) election
  
• What are ISOs and NSOs?
  
• What are RSAs?
  

Benefits of 83(b) elections

The 83(b) election for stock or equity in a company carries several benefits. Generally, however, these benefits pan out only if the company grows in value over time. If you make an 83(b) election, keep detailed records including the election letter, valuation used to determine the fair market value at the time of the election, and any correspondence with the IRS to reference for future tax filings.

• Tax rates: By choosing an 83(b) election, you pay taxes on the equity at its current market value, regardless of how much the value might increase in the future. If the equity’s value rises over time, you could save a substantial amount in taxes, because the appreciation won’t be taxed as income when the shares vest.

• Capital gains: When you make an 83(b) election, any future appreciation in the value of the stock is eligible for capital gains treatment if you hold the stock for the required period (typically, more than one year), even if it hasn’t fully vested. Capital gains rates are generally lower than ordinary income tax rates, which would apply to stock vesting without an 83(b) election. As of 2023, the tax rate on most net capital gain doesn’t exceed 15% for most individuals.

• Tax certainty: The 83(b) election offers more clarity on the tax implications of your equity compensation. You’ll know exactly how much you owe in taxes at the time of the election, which removes some of the uncertainty around what the tax burden might be in the future as the stock vests and potentially appreciates in value.

Risks associated with 83(b) elections

Deciding whether to make an 83(b) election depends on a variety of factors, including your view of the company’s future, financial situation, and risk tolerance. Predicting the future value of equity can be challenging. While 83(b) elections can offer benefits under the right circumstances, they also carry inherent risks.

• Up-front tax payment: By choosing an 83(b) election, you commit to paying taxes up front on the fair market value of the equity, whether or not the shares have vested. This means you’re paying taxes on assets that you don’t fully own yet and might never fully receive if certain conditions aren’t met.

• No refunds: If the value of the equity decreases after the election, you don’t receive a refund on the taxes you paid based on the initial higher value. This can be an issue in volatile markets or if the company’s fortunes decline.

• Risk of forfeiture: If you leave the company before your stock vests or if you’re otherwise unable to meet the conditions for vesting, you forfeit the unvested shares without compensation. Since you’ve already paid taxes on these shares, you don’t get the taxes back.

• Liquidity risk: You must pay the tax liability incurred from an 83(b) election even if you never sell the stock. This means you need to have sufficient liquidity to cover the tax bill without relying on selling the equity, which might not yet be liquid.

• Tax implications on loss: If you make an 83(b) election and the stock becomes worthless, you might face challenges in claiming a loss on the investment. The ability to deduct losses on your tax return can be complex and might depend on different factors, including your tax status and the nature of the investment.

Tax effects of 83(b) elections

The primary effect of an 83(b) election is the taxation shifts to the time of the grant. Without an 83(b) election, taxes are due as shares vest, and the income recognized is based on the fair market value of the shares at the time of vesting. An 83(b) also impacts your tax status in the following ways.

• Immediate taxable income: When you make an 83(b) election, you’re choosing to include the fair market value of the equity at the time of the grant in your taxable income immediately, rather than waiting until the shares vest. This is treated as ordinary income and is taxed at your regular income tax rate.

• Long-term capital gains: After making the 83(b) election, any increase in the value of the stock will be taxed as capital gains when you sell the shares, provided they are held for the necessary period (over a year). If the shares appreciate after the election, this could result in lower taxes compared to the ordinary income tax rates that would apply to the vested shares without the election.

• Alternative Minimum Tax (AMT) liability: The 83(b) election can also have implications for the AMT, a parallel tax system designed to ensure that taxpayers with substantial deductions or certain types of income pay at least a minimum amount of tax. Including the income from the 83(b) election could potentially trigger or increase AMT liability.

• Tax losses: If the stock value decreases after you make an 83(b) election, recognizing a tax loss can be complex. You might only be able to take a capital loss when the stock is sold or becomes completely worthless, which might not fully offset the initial tax payment made at the time of the election.

What is the 30-day deadline for 83(b) elections?

The IRS gives you 30 days to decide whether to file an 83(b) election after you receive stock that is subject to a vesting schedule. You must file the 83(b) election with the IRS within 30 days of receiving the equity, or you lose the opportunity to elect for that grant. The 30-day period includes weekends and holidays. To ensure you can prove you filed your election on time, file the 83(b) election with a method that provides proof of filing, such as certified mail with a return receipt.

What happens if you choose not to file an 83(b)?

Sometimes, filing an 83(b) election is not the right choice, especially if you are uncertain about your long-term commitment to the company, concerned about the stock’s appreciation, or if the immediate tax liability of an 83(b) election is not financially viable. If you choose not to file an 83(b) election or you miss the 30-day deadline to file, the tax treatment of your restricted stock or equity compensation follows the IRS’s standard rules for these types of assets.

• Taxation upon vesting: Without an 83(b) election, you will be taxed on the fair market value of the stock at the time each portion vests. If the stock’s value increases between the grant date and the vesting dates, you will be taxed on this higher value. The income recognized at vesting is taxed at ordinary income tax rates.

• Covering tax liabilities: Often, employers will withhold taxes for vested shares, which can result in the employer selling a portion of the vested shares to cover the tax liabilities. This can affect the number of shares you retain.

• Capital gains: Any increase in the stock’s value after vesting is considered a capital gain. The holding period for long-term capital gains (which benefit from lower tax rates) begins at vesting, not at the grant date, so you would need to hold the stock for over a year post-vesting to benefit from long-term capital gains rates.

• Forfeiture: If you leave the company before the stock vests and you haven’t made an 83(b) election, you don’t pay taxes on the unvested shares because you never received them.

How to file an 83(b) election

When you file an 83(b) election, you inform the IRS that you want your stock to be taxed up front. Here’s how to do this:

• Complete the election letter: There’s no official IRS form for an 83(b) election. Instead, you’ll need to write an election letter that includes:

  • Your name, address, and taxpayer identification number (usually your Social Security number)
    
  • A description of the property you’re electing for (e.g., the number and type of shares)
    
  • The date on which the property was transferred and the tax year for which the election is being made
    
  • The nature of the restrictions on the property (e.g., vesting conditions)
    
  • The fair market value at the time of transfer (minus any amount you paid for the property, if applicable)
    
  • A statement that you’ve provided a copy of the letter to the employer or the company granting the stock
    
  • Your signature and a date, affirming that you understand the consequences and conditions of making the election
    

• Provide a copy to your employer: You must give a copy of the completed 83(b) election letter to your employer or the company from which you received the stock.

• Send the letter to the IRS: Mail the original election letter to the IRS office where you file your tax returns. You must do this within 30 days of the stock grant date. In order to have proof of the filing date, use certified mail with a return receipt.

• Attach a copy to your tax return: In the tax year in which you make the election, attach a copy of the 83(b) election letter to your federal income tax return, even if the election doesn’t result in immediate tax due.

• Keep records: Maintain a copy of the 83(b) election letter and the certified mail receipt for your records. If there is a dispute with the IRS, can you use these records to prove you filed the election on time.

Once you file an 83(b) election, it is irrevocable. Consult with a tax professional or financial advisor to determine if this election aligns with your overall financial strategy.

What are ISOs and NSOs?

Incentive stock options (ISOs) and non-qualified stock options (NSOs) are two types of stock options commonly granted to employees as part of their compensation packages. The primary distinction between the two is how they are taxed at the time of exercise (i.e., when you purchase or sell the shares): ISOs can offer tax-deferred benefits, while NSOs result in immediate taxable income. ISOs are also restricted to employees, while NSOs can be granted to a wider range of individuals associated with the company.

Incentive stock options (ISOs)

ISOs can be granted only to employees, not consultants or board members, and there’s a $100,000 limit on the value of ISOs that can become exercisable (vest) in any one year.

• Tax treatment: ISOs offer favorable tax treatment under the Internal Revenue Code if you meet the qualifying disposition, meaning that you hold the shares for at least one year after the exercise date and two years after the grant date. If you meet these conditions, the difference between the grant price and the market price at the time of exercise is taxed as long-term capital gains rather than as income, which typically means a lower rate. This difference in price could still be subject to the Alternative Minimum Tax (AMT).

• 83(b) tax election: You can file an 83(b) election if you want to exercise your ISOs before they’re fully vested, allowing you to avoid higher taxes on any potential rise in the fair market value as they continue to vest.

Non-qualified stock options (NSOs)

NSOs can be granted to employees, directors, contractors, and others, making them a more flexible option for companies that want to provide stock options to a broader group of individuals.

• Tax treatment: NSOs do not receive the same tax benefits as ISOs. When you exercise NSOs, the difference between the exercise price (the price at which you can buy or sell the shares) and the market value at the time of exercise is treated as ordinary income and subject to income tax and employment tax withholding.

• 83(b) tax election: Filing an 83(b) election for NSOs allows you to pay capital gains tax rather than income tax on any increase in the value of the stock when you sell.

What are RSAs?

Restricted stock awards (RSAs) are a form of equity compensation that employers offer employees. RSAs give employees the right to acquire or receive shares once they meet certain requirements, typically tied to employment period or performance milestones. RSAs should not be confused with restricted stock units (RSUs): RSUs are promises to grant stock or cash equivalent to the value of stock in the future, with no shareholder rights until vesting, while RSAs provide stock from the start. RSAs also differ from stock options such as ISOs or NSOs, which give employees the right to purchase company stock at a set price after a vesting period. RSAs give employees immediate ownership of the stock, subject to vesting, without the need to purchase the shares.

• Vesting schedule: Typically, RSAs are subject to a vesting schedule. Vesting can be based on time, in which shares vest progressively over a period of employment, or performance, in which vesting occurs after an employee achieves specific goals.

• Stakeholder rights: Even before vesting, employees typically have the rights of a shareholder (e.g., voting rights, receiving dividends) unless the plan specifies otherwise.

• Taxation: RSAs are taxed as ordinary income at the time they vest. The taxable amount is the fair market value of the shares on the vesting date.

• 83(b) tax election: Employees have the option to elect under Section 83(b) of the IRS Code to recognize the fair market value of the shares at the time of the grant as ordinary income rather than waiting until the shares vest.

Holding RSAs involves a risk-reward calculation. If the company’s stock value decreases, so does the value of the RSA. But unlike stock options, RSAs retain value as long as the stock is worth more than zero, because there’s no exercise price.