Most people have heard of the famous Internal Revenue Code sections 401(k), 403(b), 121, and 1031, yet there are a few that tend to slip under the radar for most taxpayers. One code section that has a meaningful impact on a taxpayer’s return is 83(b).
At its most basic level, 83(b) allows a taxpayer to be taxed on the current value of stock, even though the stock is subject to forfeiture. When making the election a taxpayer is essentially telling the IRS “Tax me on this now, even though it wouldn’t ordinarily be taxable to me!” What kind of people willingly pay tax ahead of time? The smart ones.
There are generally two instances where an 83(b) election can be helpful for employer stock: 1. Restricted stock awards (RSA’s) or 2. Incentive stock options. For this blog post, we’re going to stick to RSA’s. An RSA is a company grant of stock. It typically has a vesting schedule spanning a term of years. When the stock vests, the employee experiences a taxable event. In the beginning of the vesting, the stock may have very little value; but as the years go on, so long as the company is doing well, the value of the stock will continue to increase. As the value increases, so does the tax liability.
This is where 83(b) comes in. If an employee makes an 83(b) election before vesting, they get taxed at the date of the election. Even though when the stock actually vests it is more valuable, the taxpayer doesn’t recognize income. Only when the stock is sold will they have additional gains (and likely long-term capital gains to boot!).
In Part II, we’ll investigate some of the drawbacks of an 83(b), and give an example.