When an individual is granted stock as compensation from his/her employer, the taxes may either be received fully at the time of grant or may be received incrementally along a vesting schedule. Naturally, the IRS considers this stock to be a form of financial gain that is subject to taxation. Under this default assumption, an individual pays taxes based on the value of stock at the time of vesting. However, under the 83(b) election, the individual may choose to pay taxes immediately upon the grant of the stock, rather, than waiting to pay taxes on the vested stock. As the stock is (likely) worth substantially less at the time of grant than at the time of vesting, less taxes will be owed on the principle. Thus, the 83(b) election presents a unique opportunity with massive tax implications if taken advantage of appropriately.
Does IRS Form 83(b) Apply To Me?
The 83(b) election is for individuals (founders, service-provider, or employee) who receive stock that is subject to a vesting schedule. The election is not necessary if the individual has no intention to exercise his/her stock options early and/or if the individual receives the full grant of stock (and therefore, not subject to a vesting schedule). An 83(b) election with the IRS must be made within 30 days of a stock purchase; individuals typically make the election as soon as the stock purchase agreement is signed, as the 30 days includes weekends and holidays—no exceptions.
Consequences of the 83(b) Election
Making the 83(b) election is a commitment to paying taxes “at the moment” on the difference between the price of the stock and the fair market value of the stock. As a result, individuals making this election typically pay little to no taxes because the fair market value of the stock is negligible. If the purchase price and the fair market price is the same, no tax needs to be paid at all.
Of course, if the fair market value of the stock is significantly different than the amount paid, the 83(b) election does not provide any benefit. Recall that filing an 83(b) election requires paying taxes when the stock option was granted and therefore, if the difference between the amount paid on the stock and the fair market price is large, the tax paid for those shares will be substantial. Moreover, if the stock becomes worthless, there will be no benefit from the tax that is paid initially for electing 83(b). Ultimately, it is only beneficial to make this election if the purchase price of the stock and fair market value are the same or if the difference is insignificant.