how to file an 83 b election
the 83 b election applies to equity that is subject to vesting and it alerts the internal revenue service irs to tax the elector for the ownership at the time of granting rather than at the time of stock vesting 1the 83 b election documents must be sent to the irs within 30 days after the issuing of restricted shares in addition to notifying the irs of the election the recipient of the equity must also submit a copy of the completed election form to their employer 2in effect an 83 b election means that you pre pay your tax liability on a low valuation assuming the equity value increases in the following years however if the value of the company instead declines consistently and continuously this tax strategy would ultimately mean that you overpaid in taxes by pre paying on higher equity valuation 3typically when a founder or employee receives compensation of equity in a company the stake is subject to income tax according to its value the tax liability is based on the fair market value of the equity at the time of the granting or transfer minus any cost of exercising or buying the equity shares the tax due must be paid in the actual year the stock is issued or transferred however in many cases the individual receives equity vesting over several years employees may earn company shares as they remain employed over time in which case the tax on the equity value is due at the time of vesting if the company s value grows over the vesting period the tax paid during each vested year will also rise in accordance 43example of an 83 b electionfor example a co founder of a company is granted 1 million shares subject to vesting and valued at 0 001 at the time the shares are granted at this time the shares are worth the par value of 0 001 x number of shares or 1 000 which the co founder pays the shares represent a 10 ownership of the firm for the co founder and will be vested over a period of five years which means that they will receive 200 000 shares every year for five years in each of the five vested years they will have to pay tax on the fair market value of the 200 000 shares vested 5if the total value of the company s equity increases to 100 000 then the co founder s 10 value increases to 10 000 from 1 000 the co founder s tax liability for year 1 will be deduced from 10 000 1 000 x 20 i e in effect 100 000 10 000 x 10 x 20 1 800 if in year 2 the stock value increases further to 500 000 then the co founder s taxes will be 500 000 10 000 x 10 x 20 9 800 by year 3 the value goes up to 1 million and the tax liability will be assessed from 1 million 10 000 x 10 x 20 19 800 of course if the total value of equity keeps climbing in year 4 and year 5 the co founder s additional taxable income will also increase for each of the years if at a later time all the shares sell for a profit the co founder will be subject to a capital gains tax on their gains from the proceeds of the sale 6for restricted stock you must file your 83 b election within 30 days of receiving your shares for stock options you must file 83 b within 30 days of exercising your options 783 b election tax strategythe 83 b election gives the co founder the option to pay taxes on the equity upfront before the vesting period starts this tax strategy allows the co founder to only pay taxes on the fair market value of the shares minus the cost of exercising the options 7 if the fair market value of the shares is equal to their strike price the taxable gain is zero the 83 b election notifies the irs that the elector has opted to report the difference between the amount paid for the stock and the fair market value of the stock as taxable income the share value during the 5 year vesting period will not matter as the co founder won t pay any additional tax and gets to retain the vested shares however if the shares are sold for a profit a capital gains tax will be applied 63following our example above if the co founder makes an 83 b election to pay tax on the value of the stock upon issuance the tax assessment will be made on the difference between the shares strike price and their fair market value if the stock is sold after say ten years for 250 000 the taxable capital gain will be on 249 000 250 000 1 000 249 000 the 83 b election makes the most sense when the elector is sure that the value of the shares is going to increase over the coming years also if the amount of income reported is small at the time of granting an 83 b election might be beneficial in a reverse scenario where the 83 b election was triggered and the equity value falls or the company files for bankruptcy then the taxpayer overpaid in taxes for shares with a lesser or worthless amount unfortunately the irs does not allow an overpayment claim of taxes under the 83 b election for example consider an employee whose total tax liability upfront after filing for an 83 b election is 50 000 since the vested stock proceeds to decline over a 4 year vesting period they would have been better off without the 83 b election paying an annual tax on the reduced value of the vested equity for each of the four years assuming the decline is significant another instance where an 83 b election would turn out to be a disadvantage will be if the employee leaves the firm before the vesting period is over in this case they would have paid taxes on shares that would never be received also if the amount of reported income is substantial at the time of stock granting filing for an 83 b election will not make much sense benefits of 83 b electionan 83 b election offers significant benefits for individuals receiving restricted stock or property by choosing this option they can pay taxes upfront based on the property s fair market value at the time of grant potentially at a lower rate compared to when it vests this upfront taxation can lead to tax savings especially if the property s value is expected to appreciate significantly furthermore making the election allows for more favorable tax treatment on future gains taxing appreciation at the lower capital gains rate rather than ordinary income additionally individuals who make the 83 b election may have the opportunity to deduct losses if the property s value decreases before vesting providing a level of tax flexibility and protection overall the 83 b election offers a strategic approach to managing tax liabilities and optimizing tax treatment for recipients of restricted property 