04/14/2025

Next Level Thinking: Understanding the 83(b) Election

What is the 83(b) Election?

The 83(b) election is a provision under the U.S. Internal Revenue Code that allows individuals who receive restricted stock or equity subject to vesting to pay ordinary income taxes on the total fair market value of the equity at the time of the grant. The holder can then pay the lower capital gains taxes on any growth, rather than paying ordinary income taxes on the total value at the time of vesting.

Who Should Consider the 83(b) Election?

The power of the 83(B) Election comes from locking in an income tax payment on receipt of an early (and, hopefully lower) stock valuation and paying a lower ordinary income tax upfront.

It is particularly relevant for:

Startup founders,
Early-stage employees, and
Executives who receive equity grants subject to vesting schedules.

It is beneficial for anyone who expects their stock value to increase significantly in the future.

Impact of Making the Election

Making the Election:
- An employee receives 10,000 shares at $1 per share ($10,000 total).
- If they file an 83(b), they pay ordinary income tax on $10,000 now.
- Assuming they are in the highest federal tax bracket (37%), their immediate federal tax cost is $3,700.
- If the stock rises to $100 per share at vesting, they only owe long-term capital gains tax (20% federal plus 3.8% net investment income tax, totaling 23.8%) on the increase.
- If they sell at $100 per share, their taxable gain is $990,000, and they owe $235,620 in federal capital gains tax. Total federal tax paid: $239,320.
Not Making the Election:
- The recipient is taxed as the stock vests, based on its fair market value at that time.
- If the stock reaches $100 per share at vesting, they owe ordinary income tax on $1,000,000.
- At the highest federal rate (37%), they would owe $370,000 in federal taxes at vesting.
Net Impact: In this example, filing an 83(b) election saves the recipient $130,680 in federal taxes.

Note: this example only considers federal taxes and does not factor in state and local taxes, which vary by jurisdiction and may impact overall tax savings.

Implementation: How and When to File an 83(b) Election (The Paper Work is Important!)

File a written election with the IRS within 30 days of receiving the equity grant. There are no extensions for the 30-day deadline, making timely filing crucial.
Retain proof of filing (such as a certified mail receipt) as the IRS will not confirm receipt.
Send a copy of the election to their employer or granting entity.
Include the election in their tax records for future reference.

Common Mistakes in Filing the 83(b) Election

Missing the Deadline – Failure to file within 30 days makes the election invalid.
Incorrectly Completing the Form – Errors in valuation or missing signatures can result in rejection.
Not Maintaining Proper Records – The IRS is keen to review these transactions.
Failing to Send Copies to the Employer – This is a required step for valid election.
Not Understanding the Tax Implications – There is risk in paying a tax upfront. Paying tax on stock that ultimately loses value could result in unnecessary tax burdens.
Not Keeping Track of Permissible Selling Windows – It is important to make sure that the timeline of the tax planning integrates with any restrictions on stock selling.
Not Analyzing the Source of Funds for Tax Payment – Some company stock programs allow for the conversion to stock proceeds for tax payment. While this may be advisable, there may be an opportunity to pay for the upfront income tax liability with outside funds an increase the power of the transaction.

Conclusion

The 83(b) election is a valuable tool for those receiving restricted equity, but it requires careful consideration and timely action. Understanding the benefits, risks, and filing requirements can help equity holders make informed financial decisions that optimize tax outcomes.

It’s important to work with an advisor that understands a client’s total picture. This is particularly true when analyzing the risk reward scenario of an 83(B) election and identifying the source of funds to pay the upfront taxes.

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