In this article, we’ll provide you with an overview of 83(b) elections, including:
What is an 83(b) election?
If you receive restricted stock or have the ability to exercise your stock options prior to vesting (early exercise), an 83(b) tax election enables your equity to be taxed when it is issued rather than when it vests. Typically, the fair market value (FMV) of your equity is much lower when it is issued than when it vests. For individuals who early exercise options, if the exercise price equals the current FMV, it means you could owe no taxes when you exercise.
However, this 83(b) election must be filed within 30 days of the stock issuance in order to qualify for the special tax treatment. You may recall the IRS extended the 30-day filing deadline in 2020 due to delays in mail delivery times. In 2022, it’s back to business as usual.
What is the benefit of an 83(b) election?
If your equity goes up in value, the benefit of an 83(b) election is that you pay less taxes on your equity. Additionally, depending on the type of equity (and subject to meeting holding period requirements), if you sell the options you’re only taxed at the capital gains tax rate – a rate much lower than ordinary income tax.
Example impact of 83(b) election
|83(b) election||Without an 83(b) election|
|Number of RSs issued||100,000||100,000|
|Taxable event||At time of RS grant||At time of RS vesting|
|FMV per share at time of grant||$1.00||$1.00|
|FMV per share at time of vesting||$5.00||$5.00|
|FMV of all shares at time of taxable event||$100,000||$500,000|
|Taxes paid at taxable event (35% ordinary income tax rate)||$35,000||$175,000|
What happens if you don’t make an 83(b) election?
If you don’t make an 83(b) election you’re likely to pay more in taxes over the course of owning this stock (see table above). As was mentioned above, this is because you’ll pay taxes on the difference between the FMV at the date of vest over the purchase price rather than the FMV at the date of exercise over the purchase price. Typically, the FMV when stocks vest is higher than the FMV on the grant date.
Why would you not make an 83(b) election?
There are reasons why an 83(b) election might not make sense for you. Those reasons include:
- You expect share value to decrease – If you anticipate the value of your shares will decrease, filing an 83(b) election can ultimately cost you money because you are paying taxes at a higher value.
- You don’t plan to stay at the company – If you don’t think you’ll remain at your company through vesting periods or other stock option landmark events, it doesn’t make sense to pay taxes on shares you won’t actually receive.
- You think the stock value is too high – If the equity value when receiving the shares is too high for you to take the immediate tax hit, then you are left with almost no choice and must pay taxes on the FMV at vesting and other taxable events.
- You don’t plan on holding the stock for long-term capital gain treatment – With stock options, you must hold the shares for the longer of 1 year from the date of exercise or 2 years from the date of grant in order to qualify for long-term capital gain treatment. An 83(b) election for stock options only affects your alternative minimum tax (AMT) income, and not your capital gains treatment. Typically, if you don’t meet the holding period, you will realize ordinary income equal to the amount of AMT income originally realized in the year of exercise. With early exercise, if you don’t meet the holding period, ordinary income will be realized on the difference between the FMV on the date of vest over the purchase price rather than the difference between the FMV on date of exercise over the purchase price.
Should you file an 83(b) election?
Everyone’s situation is different, but generally 83(b) elections help you pay less in taxes. If you’re confident your company’s value will only increase and you have the cash to cover exercise costs and the possible associated income taxes, then it might be worthwhile to file. However, seeking the advice of a tax advisor who works with startup founders and employees, and understands the complexities surrounding 83(b) elections can help you make the best decision for your situation.
Learn more about how a Harness Tax Advisor can help:
- Determine if filing an 83(b) election makes sense
- File an 83(b) election
- Maximize your tax savings from now through a liquidity event
- Manage added complexities from cross-state or international moves
- Identify tax savings or opportunities in how you manage your equity
- Accurately report tax filings and determine if quarterly estimated tax payments are necessary