What is an 83(b) election (plain-language definition)
– An 83(b) election is a small, time‑limited tax choice under Internal Revenue Code section 83. It lets a recipient of restricted equity (shares or other property that are subject to vesting) elect to recognize ordinary income at the date of grant instead of waiting until each tranche vests. In practice you “pre‑pay” income tax on the grant‑date fair market value (FMV) of the equity. If the company’s value rises after the grant, future appreciation is generally taxed later as capital gain, not ordinary income.
Key terms (defined once)
– Vesting: the schedule by which you earn the right to keep shares over time (e.g., 25% per year for four years).
– Fair market value (FMV): the price a willing buyer and seller would accept for the shares at a given date.
– Ordinary income tax: tax applied to compensation and wages; usually higher than capital-gains rates.
– Capital gains tax: tax on profits from the sale of an asset held over time; long‑term rates generally are lower than top ordinary rates.
– Strike price (for options): the price you pay to exercise an option; taxable gain is the FMV at exercise minus strike, absent an 83(b) election.
– Profits interest: a type of LLC equity designed to give future profit shares without immediate taxable income if structured correctly.
How the 83(b) election works (mechanics and effects)
– Default rule: if you receive restricted stock and do nothing, you pay ordinary income tax on the FMV of the shares as each portion vests. Each vesting event triggers income tax on the value of the vested shares at that time.
– With 83(b): you notify the IRS that you elect to include the difference between FMV at grant and any amount you paid as income in the tax year of the grant. After that, additional appreciation becomes eligible for capital gains treatment (if you meet the holding‑period rules). The election is irrevocable once the 30‑day deadline passes.
When an 83(b) election is typically beneficial
– Grant‑date FMV is very low (so the tax now is small).
– You expect the equity to increase substantially in value.
– You plan to hold long enough to qualify for long‑term capital gains on future appreciation.
– You are confident you will not forfeit the unvested shares (or willing to accept the forfeiture risk).
– You have cash to pay the tax bill up front.
When it can be detrimental
– The company’s value falls or you forfeit the unvested shares: taxes already paid are generally nonrefundable.
– You lack cash to pay the immediate tax.
– Grant‑date valuation is not meaningfully lower than future valuations.
What happens if you do NOT file 83(b)
– You recognize ordinary income equal to FMV at each vesting event. That income is taxed at ordinary rates (often higher than capital‑gains rates). Your capital‑gains holding period begins when each tranche vests.
Filing — step‑by‑step checklist
1. Prepare the election statement containing the required items:
– Your name, address, and taxpayer identification number (TIN).
– Description of the property (number and class of shares).
– Date of grant and the date the shares were transferred to you.
– FMV per share at grant and total FMV.
– Amount paid for the shares (if any).
– A statement that you are making the election under IRC §83(b).
– Your signature and the date signed.
2. Mail the original 83(b) election to the IRS service center where you file your tax return — must be postmarked within 30 calendar days after the grant or exercise date. If the 30th day falls on a weekend or federal holiday, it must be postmarked by the next business day.
3. Provide a copy of the completed election to your employer (or the issuing entity).
4. Attach a copy of the election to your federal income tax return for the taxable year in which the property was transferred.
Note: There is no official IRS paper form for 83(b); the election is a signed statement that meets the requirements above.
Short decision checklist before filing an 83(b)
– Is grant‑date FMV low relative to likely future value?
– Can you pay the tax bill now if FMV > amount paid?
– How likely is it you will remain through the vest schedule (low forfeiture risk)?
– Do you want to start the capital‑gains holding period now?
– Is the company’s capitalization and valuation well documented (to defend FMV if audited)?
Worked numeric example (concise)
Assumptions
– Grant: 1,000,000 restricted shares at grant‑date FMV = $0.001/share → total FMV = $1,000.
– Vesting: five years, 200,000 shares vest per year.
– Full value at sale (after vesting): $2.00/share → total value when fully vested/sold = $2,000,000.
– Ordinary income tax rate (hypothetical) = 35%. Long‑term capital gains rate = 20%.
– You paid $0 for the shares at grant (common for founder grants); basis if you pay is included.
Scenario A — You file 83(b) at grant
– Year 0: Recognize $1,000 ordinary income; tax = $1,000 × 35% = $350 (pay now).
– Holding period starts at grant. Later sale at $2,000,000:
– Capital gain = $2,000,000 − $1,000 = $1,999,000; tax at 20% = $399,800.
– Total tax (simplified) = $350 + $399,800 = $400,150.
Scenario B — You do not file 83(b)
– Taxes are ordinary income as each 200,000 tranche vests at that moment. In total you will recognize roughly $2,000,000 as ordinary income (less any small amount paid at grant).
– Total ordinary income tax ≈ $2,000,000 × 35% = $700,000.
– If you later sell, capital gains may be small (basis equals value at vesting), so overall taxes are significantly higher in this illustration.
Takeaways from the example
– Filing 83(b) can dramatically lower taxes in scenarios where FMV at grant is tiny and ultimate value rises a lot. The downside risk is losing the shares before vesting or a decline in value — you don’t get a tax refund if that happens.
Profits interest (brief note)
– “Profits interest” is an LLC equity grant that often gives the recipient a right to future profits without current taxable income, if it meets specific conditions. It’s a different legal and tax construct than corporate restricted stock; the 83(b) considerations are not identical.
Important practical notes and caveats
– The 30‑day deadline is strict; late filings are generally not accepted.
– Keep contemporaneous documentation of FMV and the filing (copies, proof of mailing).
– An 83(b) election is irrevocable once filed.
– Consult a qualified tax advisor or attorney for your situation. This explainer is educational, not tax or legal advice.
Reputable sources for further reading
– Investopedia — “83(b) Election” (overview and examples): https://www.investopedia.com/terms/1/83b-election.asp
– Cornell Law School, Legal Information Institute — 26 U.S. Code § 83 (statutory text): https://www.law.cornell.edu/uscode/text/26/83
– U.S. Securities and Exchange Commission (SEC) — Investor bulletin on employee equity: https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_employee_stock_options.html
– Internal Revenue Service — general stock options / equity compensation topic: https://www.irs.gov/taxtopics/tc427
Educational disclaimer
This explainer is for educational purposes only and does not constitute tax, legal, or financial advice. For advice specific to your circumstances, consult a licensed tax professional or attorney.