Section 83 of the IRS tax code governs the timing and amount of compensation income that is taxable to a taxpayer. This section is essential to executives as they have many decisions to make regarding their equity compensation. One of the choices is an 83(b) election, which gives executives the option to pay taxes on the total fair market value of restricted stock at the time of granting with the hope of paying fewer taxes in the future. Below, we will explore some of the factors to consider in determining whether an 83(b) election makes sense for your executive equity compensation.
A Few Pros of Making the Election
- The election makes the grant date the relevant date, rather than the vesting date. Meaning, it recognizes the taxable income as of the grant date, based on the fair market value of the stock on that date. By making the election, you may avoid federal earned income tax consequences at the time the stock vests.
- In the event the price granted is equal to the full fair market value of the equity, you will not likely have any federal income tax liability as a result of the purchase.
- The election can be beneficial if, at the time of vesting, the stock is illiquid or you are prevented from trading, yet you owe taxes on the vested award.
A Few Cons of Making the Election
- If the equity does not vest or is forfeited, you cannot recapture or deduct any of the taxes paid as a result of making the election. The executive’s capital loss is limited to any amount you paid for the equity award out-of-pocket.
- It’s also unlikely you’ll be able to revoke an 83(b) election. For example, if you made a mistake in the number of shares granted or the value was mistakenly overvalued in the 83(b) election, you can’t lower the value without IRS permission.
Another scenario to consider is taking the equivalent amount of money that would be paid with an 83(b) election and investing that amount in company stock.
What Do the Numbers Tell Us?
The analysis shows that if you are working for a publicly-traded company, an 83(b) election most often does not make sense. You are likely better off utilizing the alternative strategy above, taking the amount of taxes you would have paid and purchasing the stock outright. You could be left with more money in your pocket, and you might not face the risk of paying taxes on an award that may be forfeited or holding stock that might decrease in value.
For executives of non-publicly traded companies, especially for startups with founder’s stock that have little to no real value, consider using the 83(b) election. The risks are minimized, and there is no ability to purchase the stock on the open market.
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 and include a copy with their annual tax return.
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