The 83(b) election is a provision that gives an employee or startup founder the option to pay taxes on the total fair market value of restricted stock at the time of granting — rather than at the time of stock vesting.
This provision only applies to vesting stocks.
Documents must be sent to the Internal Revenue Service (IRS) inside 30 days of the restricted shares being issued. The same documents must also be handed to the individual’s employer.
It is important to remember, even when using the 83(b) election, capital tax must be paid when selling stock.
How is this Helpful to Investors?
An individual can choose to pay their tax liability in advance, assuming that the equity’s value will increase, which saves money for the individual.
This can work counterproductively, however, if the equity’s value drops. Meaning the individual overpaid their taxes, as they paid on a higher valuation.
For example, a startup founder is granted 100 shares, vesting over a 10 year period, valued at $1. Meaning his total shares are worth $100 — at this point in time.
Without the 83(b) election, every year during the vesting period the startup founder will be taxed on the current value of the stock. The stock may rise year on year, meaning they’ll have to pay more tax than when they were granted the shares.
With the 83(b) election, however, the startup founder can opt to pay taxes on the equity before the vesting period starts. This protects the individual from the equity valuation rising.
It may not be smart to use this strategy if an individual plans on leaving the company before the vesting period is over. This is because they would have paid taxes on stocks they never received. That being said, it may still save money in certain scenarios.
83(b) can also be applied to property, as well as company stock. As in the startup example, 83(b) allows a taxpayer to treat unvested property as vested and pay tax earlier. This is betting, as Cooley explains, that the property will meet vesting requirements and rise in value.