When you are given equity in a company as compensation, it is taxed at the fair market value of that equity at the time it is transferred to you. The exception, however, is when such equity is subject to a vesting agreement -- as is commonly the case with equity grants to founders and other early employees at startups. In such cases, you are taxed when the stock actually vests—an amount that would be (assuming all goes as planned) significantly greater than the amount you would have owed if you were taxed at the time of the equity grant. An 83(b) election addresses just this issue by giving you the opportunity to save that money by choosing to be taxed at the time of transfer.
For many founders and early stage employees, 83(b) elections can save a significant amount of money on your federal taxes. However, it’s important to file them properly and in the correct timeframe or you forfeit the benefits afforded by the 83(b) election. A tax attorney from the Priori network can help you analyze whether making an 83(b) election makes sense for you and, if it does, help you make the appropriate filings.
Understanding 83(b) Elections
Generally, equity is taxed in the period in which it vests -- and at its value in that vesting period. However, section 83(b) of the Internal Revenue Code permits an equity-holder to elect to be taxed on the value of equity in the period in which such equity was received rather than the period in which it vests. In the event the value of the equity increases between the time in which it was received and the period in which it vests, making this election reduces your taxes, perhaps significantly. Of course, there is always the risk that the value of the equity decreases before it vests, in which case if you made an 83(b) election you would end up paying a higher tax than you would otherwise have paid.
When Should You File an 83(b) Election?
If you decide to make an 83(b) election, you must make your filing with the IRS and notify the company that issued you the equity within 30 days of being issued the equity.
Why File an 83(b) Election
The main reason to file an 83(b) election is to minimize your tax burden. You save money two ways. First, you pay taxes on the vested stocks as compensation income only at the time of transfer, meaning that you owe no federal income taxes when the stocks do vest—only long-term capital gains at a much lower tax rate. Secondly, filing an 83(b) election relieves you of any tax burden on the stocks’ appreciation during the interim before it vests. If you do not file an 83(b) election, you will be taxed yearly on the appreciation of the restricted shares (known as phantom income) even though you do not yet have access to that income.
Priori tax lawyers can help you make a decision about filing for an 83(b) election and guide you through the process for approximately $150 per hour to $350 per hour. Priori clients enjoy a net-15% discount on standard hourly rates. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and free price quote from one of our lawyers.
Are there any downsides to filing an 83(b) election?
If you retain your equity and it goes up in value, there generally are not major disadvantages to filing an 83(b) election; however, in the event that the company dissolves, making the stock useless, you get no benefit from the income tax you already paid. In addition, if you forfeit the stock, you can’t take a deduction for the tax you already paid on the stock.
Can I file an 83(b) election for any stock option received?
No. You can only file an 83(b) election if the equity vests at some point in the future or is otherwise subject to time-based restrictions. Generally, regular stock options do not qualify for an 83(b) election.