As an employee, founder or an investor in a startup, you may receive restricted stock that will vest at a later date. Upon receipt, you have the option of making an 83(b) election with the IRS. But what is an 83(b) election? Why should you consider making one, and what’s the process for doing so? The following paragraphs contain information about the basics of an 83(b) election and why it may be beneficial to file one.
What is it:
An 83(b) election is a optional provision that directs the IRS to tax the stock at the time of the grant, when it may be worth very little or when payment is made. The relatively low worth of the stock at the time of the grant (versus at the time that it vests) helps the grantee minimize his or her potential tax liability when he or she opts for an 83(b) election.
Why should you do it:
For a startup, the stock is likely to be worth much less at the time it’s granted than at the time it vests. Ideally, making an 83(b) election will result in paying less taxes because you’ll be taxed on the stock at the time of the grant instead of when it vests, when it hopefully holds a higher value.
When you should do it:
An individual must file the letter of election with the IRS either prior to the date of the stock purchase or within 30 days after the purchase date. There is no exception to the 30-day rule.
The following circumstances would be advantageous for an 83(b) election:
• If the amount of income reported at grant is small;
• If the stock has moderate to high growth prospects; and
• If the risk of stock forfeiture is very low.
However, under these circumstances apply, you might reconsider making an 83(b) election:
• If there is a moderate to high risk of stock forfeiture; or
• If there’s a heavy tax burden at the time of the grant in addition to low to moderate growth prospects.
How you should do it:
Within 30 days of the purchase date, you must send a letter to the IRS stating your intent to make the election. You must include the following items in the letter:
- Your name, address, and taxpayer identification number.
- A description of each property for which you are making the choice.
- The date or dates on which the property was transferred and the tax year for which you are making the choice.
- The nature of any restrictions on the property.
- The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property for which you are making the choice.
- Any amount that you paid for the property.
- A statement that you have provided copies to the appropriate persons.
You must send your letter to the IRS where you file your tax returns; you can find the address for the office you need on the IRS website. You should also make copies of your 83(b) election documents because in addition to filing with the IRS within 30 days of the grant, you also have to file it with your personal income tax return. Finally, send a copy of the election to the company that granted you the stock for them to keep in their records.