What is an 83(b) election?
An 83(b) election is a way to potentially limit your tax liability for gains on shares of company stock. It allows you to pay taxes on shares before they vest, when their value may be still relatively low. You may choose to file an 83(b) election when you receive shares of restricted stock or purchase shares through early exercise of stock options. When an 83(b) election is filed, the stock is taxed at its current value on the date of grant rather than at the time it vests.
How can an 83(b) election affect your taxable income?
An 83(b) election isn’t guaranteed to save on your tax bill. If a company does well, it’s stock is generally expected to increase in value over time. If a pre-IPO shareholder in such a company files an 83(b) election, their taxable income would be lower than they would if their shares were taxed later. On the other hand, a company’s stock could decrease in value (or the company could go under altogether). In this case, paying taxes early on unvested shares would mean paying taxes on a higher income than if tax liability were calculated later. Because of this risk, it’s important to consult with a trusted investment advisor before deciding whether to file an 83(b) election.
How does an 83(b) election affect holding periods?
In addition to making your unvested shares taxable at their current value, filing of an 83(b) election starts the clock for important holding periods. To qualify for long-term capital gains treatment of gains from stock sales, you must first hold the stock for at least one year. Gains from the sale of shares that are held for less than one year are treated as regular income, which generally carries a higher tax rate. When you make an 83(b) election, that one-year holding period begins immediately.
If your shares are qualified small business stock (QSBS), holding these for at least five years before selling can make the gains exempt from federal taxes. Filing an 83(b) election starts the clock on this holding period, as well. If you do not file an 83(b), then these holding periods begin at the time your shares vest.
What is the procedure for filing an 83(b) election?
File within 30 days of receiving restricted shares.
After you receive restricted shares, you have 30 days to make an 83(b) election by sending a completed form and cover letter to the IRS. You can use the 83(b) election form that the IRS provides here on page 9, the sample cover letter and 83(b) form provided by the SEC here, or similar forms provided by your attorney or investment advisor.
Sign and mail copies of the completed forms to both the IRS and your employer.
Make at least four copies of the completed 83(b) election form and cover letter. Send two copies of your documents to the IRS via certified mail with return receipt along with a postage-paid self-addressed envelope. Use the same IRS address that you use to file your taxes. The filing is considered complete on the postmark date. You’re not legally required to submit a second copy and return envelope, but if you do, the IRS will stamp one of them and send it back to you. Mail a third copy of the documents to your employer, and keep another for your records.
Check your local tax laws.
In some jurisdictions, state or local tax authorities must also receive copies of an 83(b) filing. Check with your local tax professional about the requirements of your state tax laws.
Should I make an 83(b) election?
An 83(b) election has the potential to make an immense difference in the amount of tax you pay on your company stock. If you currently have restricted stock that is eligible for early exercise, speak with a financial professional who is experienced in the IPO process to evaluate whether filing an 83(b) is in your best interest. To learn more about company stock and the IPO process, see WRP’s Insights.