An 83(b) election is a provision under the U.S. Internal Revenue Code (IRC) that gives an employee the option to pay taxes on the total fair market value of the restricted stock at the time of granting rather than at the time of vesting. Here’s a simple example to illustrate how it works:
Example Without an 83(b) Election:
Suppose an employee is granted 1,000 shares of restricted stock worth $10 per share. The stock vests over four years (25% each year).
- Year 1: The first 250 shares vest. If the stock price is now $20 per share, the employee is taxed on $5,000 of income ($20 * 250 shares).
- Year 2: The next 250 shares vest. If the stock price is now $25 per share, the employee is taxed on $6,250 of income ($25 * 250 shares).
- Year 3: The next 250 shares vest. If the stock price is now $30 per share, the employee is taxed on $7,500 of income ($30 * 250 shares).
- Year 4: The final 250 shares vest. If the stock price is now $35 per share, the employee is taxed on $8,750 of income ($35 * 250 shares).
In total, the employee pays taxes on $27,500 of income, which can be significant if the employee’s tax rate is high.
Example With an 83(b) Election:
Now suppose the employee makes an 83(b) election at the time of the grant.
At grant: The employee pays taxes on $10,000 of income ($10 * 1,000 shares), regardless of how much the shares are worth when they vest.
In this scenario, the employee only pays taxes on $10,000 of income, even if the shares increase in value significantly over the vesting period. This can result in significant tax savings if the stock appreciates, as in our example. However, the employee takes the risk that the stock price will fall, in which case they would have overpaid taxes.
It’s important to note that the 83(b) election must be filed with the IRS within 30 days of the date that the shares are granted. If the employee fails to make the election within this time frame, they’re out of luck and can’t make the election later.
Also, it is crucial to remember that there are other potential tax considerations as well, such as capital gains taxes when the stock is eventually sold. Individuals should always consult with a tax advisor to understand the implications fully.
How to File Your 83(b) Election
It is actually not that hard to DIY this election by following a few simple rules. But it also helps when an experienced attorney does it for you to avoid any confusion.
To start, make sure you have signed the stock grant agreement or the stock purchase agreement, followed by the evidence of either paying in cash or check for the amount of the grant with the 83(b) election in mind.
Create a transmittal letter to the IRS. You can use this example here for your reference. The key information contained in the transmittal letter is to ask for a copy of the signed Section 83(b) election to be stamped by the IRS and sent back to you as records. Make sure you include a self-addressed envelope with sufficient stamps attached.
File out the 83(b) election letter as referenced by the IRS. Here is the link to the IRS election template, on Page 9
Mail it to the proper address based on the IRS office in charge of your region.