Founders, executives and other employees of fast growing companies – if you received or are about to receive restricted stock in connection with the performances of services that is subject to vesting, you should consider making a timely § 83(b) election.
What is a Section 83(b) Election?
A section 83(b) election is a tax election to include in your income the fair market value of property you have received in connection with the performance of services which you may not get to keep. For example when a founder or an employee sign a restricted stock purchase agreement or if a founder or an employee agree to a stock option plan that allows them to exercise their options prior to vesting, but subject to a restrictive stock agreement.
Generally, under the tax code, if you receive property in connection with the performance of services that you may not get to keep, i.e. subject to vesting, and which you can’t transfer, you don’t have to take the fair market value of that property into income until it is determined that you will either (i) get to keep it, or (ii) the property becomes transferable.
Section 83(b) provides an opportunity for you to elect to be taxed at the time of the receipt of the property instead of waiting for the property to become transferable or no longer subject to a substantial risk of forfeiture.
Why Would You Want To Do This?
Why would you want to include in your taxable income the fair market value of property in excess of what you paid for it if you might not get to keep the property? There are a few different reasons:
- Because the fair market value of the property at the time of receipt might be nominal–meaning, the tax might be insignificant, and an election will avoid a potentially much higher tax bill later.
- Because the taxpayer might be paying the fair market value of the property so that electing to be taxed on its fair market value over what was paid for it means no tax is owed.
- Because the value of the property might increase substantially and when it vests the tax on the fair market value of the property at that time might be more than the taxpayer will be able to afford.
- Because the taxpayer might want his or her capital gains holding period to start
You Do Not Have To File an 83(b) Election If Your Shares Are Fully Vested
You do not have to file a Section 83(b) election in connection with your receipt of shares if those shares are not subject to vesting. If your shares are fully vested, no Section 83(b) election is required of you.
What Is The Character Of The Income?
Under Section 83(a) of the Internal Revenue Code, a taxpayer who receives property in connection with the performance of services must generally recognize as ordinary income the difference between the value of the property and the amount paid in exchange therefor at the first time the property is either transferable or not subject to a substantial risk of forfeiture. Section 83(b) allows a taxpayer who receives property in connection with the performance of services that is subject to such restrictions (e.g., non-vested property) to elect to recognize this income at the time of transfer. The principal benefit of a Section 83(b) election is that the taxpayer can lock in appreciation which is generally taxable at capital gains rates upon later disposition.
You Can’t Make an 83(b) Election with Respect to a Stock Option
It is a common misconception, but a Section 83(b) election generally cannot be made with respect to the receipt of a private company stock option. You must exercise the option first and acquire the stock before you can make a Section 83(b) election, and you would only make a Section 83(b) election in that instance if you exercised the option and acquired unvested stock (if the stock acquired on exercise of the stock option was vested, there would be no reason to make a Section 83(b) election).
Another common misconception is that Section 83 does not apply to restricted stock that is purchased at fair market value. This is not true. Section 83 applies even to stock that has been purchased at fair market value, if the stock is subject to a substantial risk of forfeiture and received in connection with the performance of services.
How much time do you have to make an 83(b) election?
An 83(b) election has to be filed with the IRS within 30 days of receipt of the property, a copy has to be filed with the tax return of the person making the election, and a copy must be provided to the company.
Founders, executives or other employees receiving restricted stock in connection with the performance of services should consider promptly filing a Section 83(b) election, in a proper and a timely manner. Doing so could result in substantial savings in the long run.
If you have questions regarding Section 83 (b) elections, please do not hesitate to contact Larry Horwitz at firstname.lastname@example.org.