83(b) Election: Why and When to File
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Taxes are like chores. You pay what you have to, but no more than you need to.
One way to avoid overpaying is understanding the tax code and its various provisions. This can be especially true if you have a complicated tax situation, as employees or company founders with equity compensation often do. Taking advantage of the 83(b) election can help you minimize your tax outlay.
What is the 83(b) election?
When making an 83(b) election, you request that the IRS recognize income and levy income taxes on the acquisition of company shares when granted, rather than later upon vesting. The grant date is when an employee receives a company stock or stock option award. Vesting means an employee has earned actual ownership of the company shares or stock options, usually by satisfying a certain time period of employment.
Making an 83(b) election means that you’re able to pay income taxes earlier, often before your company shares have had the opportunity to appreciate in value. If and when you sell shares for a gain down the road, you’d only be responsible for capital gains taxes as opposed to ordinary income taxes, which are taxed at a higher rate.
Holding shares for over a year prior to selling means you’d pay the more favorable long-term capital gains taxes. Filing an 83(b) also means you can start the holding period clock earlier, right after the grant date, so any capital gains accrued are eligible for the lower capital gains tax rate.
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The 83(b) election can come in handy when you expect to stay with your company for the long term (since you’ll need to wait until your company shares vest to gain actual ownership), and if you expect that the value of your company shares will grow over time.
On the flip side, you could end up prepaying unnecessary taxes if you part ways with your company and never receive ownership of those company shares, or if the value of those shares decreases instead.
Who might file an 83(b) election and why
There are a few situations in which you might file an 83(b) election. If you happen to fall into either of these camps, an 83(b) election could potentially help reduce your tax burden.
Stock option holders: If you’re able to exercise your stock options early (prior to vesting), you could elect to do so and file an 83(b) election within 30 days of exercise. This way, you can potentially minimize your future tax liability if the share price of your company happens to take off.
Startup founders: In some companies, particularly startup companies, compensation for company founders or owners may include a significant amount of restricted stock (not to be confused with restricted stock units or RSUs). Restricted stock refers to company shares that are subject to certain stipulations, such as vesting and/or forfeiture (losing your shares if you leave the company). Key employees may be awarded a handsome quantity of restricted shares that could significantly increase in value from granting to vesting. Using the 83(b) election allows these employees the chance to save by shifting their tax treatment from ordinary income taxes to capital gains taxes.
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When and how to file an 83(b) election
It is critical to remember to file your 83(b) election within 30 days of being granted restricted shares or within 30 days of exercising your options early. Not doing so results in your company shares being taxed upon vesting as ordinary income. But keep in mind that filing an 83(b) election is usually irreversible, so carefully consider whether you want to do so.
How to file an 83(b) election form
Though there are benefits and drawbacks to consider when deciding whether to file an 83(b) election, the process itself is fairly straightforward.
The employee completes and signs an IRS Section 83(b) form or letter that details certain key information:
Personal identifying information (name, address, Social Security number).
Description of the property awarded (number and type of shares of which company) along with the date received or purchased, any restrictions your shares are subject to and the fair market value of the shares on the date received or purchased.
The amount paid for the company shares.
The amount the employee will indicate as gross income on their income tax return.
The employee mails the election form or letter to their IRS Service Center and provides a copy to their employer.
Best practice is to send your election form through certified mail with a return receipt in case you need to prove that it was sent by a particular date.
If you’re not sure whether the 83(b) fits with your needs, consulting with a seasoned tax or financial advisor can help you decide whether it makes sense to move forward.
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