What Is A Section 83(b) Election?

At its most basic level, a Section 83(b) election is an election to be taxed on property received in connection with the performance of services even though the taxpayer may not get to keep or may have to forfeit that property. For example, suppose you receive nontransferable shares of stock from your employer but they do not vest until you have provided 1 year of service. You could, if you wanted, wait to be taxed on those shares until 1 year passes. The problem with this approach? The shares might increase in value substantially over the course of that year and when the shares vest you may not be able to afford the taxes that become due on vesting. An alternative is available under Section 83(b) of the Internal Revenue Code. Under Section 83(b), even though you might not get the keep the property you received, or may have to forfeit it, you can elect to be taxed on your receipt of the property at the time you receive it, instead of waiting until it vests.

Section 83(b) Election

Under Section 83 of the Internal Revenue Code:

  1. a taxpayer who receives property in connection with the performance of services must generally recognize as ordinary income the difference between the value of the property and the amount paid in exchange therefor at the first time the property is either transferable or not subject to a substantial risk of forfeiture.
  2. Section 83 allows a taxpayer who receives property in connection with the performance of services that is subject to such restrictions (e.g., nonvested property) to elect to recognize this income at the time of transfer.There are a couple of benefits of a Section 83(b) election:
    • (i) the taxpayer avoids having ordinary income on vesting; and
    • (ii) the taxpayer starts the capital gains holding period.

For example, suppose a startup company founder is issued founders’ stock that is subject to a company repurchase at the stock’s cost, but the repurchase right lapses over a service based lapsing period.  This founder has received stock, but because the stock is subject to a substantial risk of forfeiture (the at-cost repurchase right lapsing over the service based vesting period), the founder does not have to pay tax on his receipt of the stock until it vests.  However, the founder may prefer to make a Section 83(b) election to pay tax on the value of the stock today because its value is lower than it is expected to be when it vests–or because the founder paid full value for it today, so the Section 83(b) election costs him no additional tax today.  The making of the Section 83(b) election also starts the founder’s capital gains holding period.

Frequently Misunderstood Points

If a founder receives shares that are fully vested–that is, not subject to an at-cost repurchase right that is lapsing over a service based vesting period–no Section 83(b) election is required.

It is a common misconception, but a Section 83(b) election generally cannot be made with respect to the receipt of a private company stock option.  You must exercise the option first and acquire the stock before you can make a Section 83(b) election, and you would only make a Section 83(b) election in that instance if you exercised the option and acquired unvested stock (if the stock acquired on exercise of the stock option was vested, there would be no reason to make a Section 83(b) election).

Another common misconception is that Section 83 does not apply to restricted stock that is purchased at fair market value.  This is not true.  Section 83 applies even to stock that has been purchased at fair market value, if the stock is subject to a substantial risk of forfeiture and received in connection with the performance of services.  See this case, Alves v. Commissioner.

An 83(b) election has to be filed with the IRS within 30 days of receipt of the property, a copy has to be filed with the tax return of the person making the election, and a copy must be provided to the company.

Additional information about making the election can be found Code of Federal Regulations.

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  • Justin

    Hi Joe, I love your blog. Great work! You wrote:

    but a Section 83(b) election generally cannot be made with respect to the receipt of a private company stock option.
    You must exercise the option first and acquire the stock before you
    can make a Section 83(b) election, and you would only make a Section
    83(b) election in that instance if you exercised the option and acquired
    unvested stock (if the stock acquired on
    exercise of the stock option was vested, there would be no reason to
    make a Section 83(b) election).

    Does this mean that an employee who receives your run-of-the-mill compensatory stock option does not need to make an 83(b) election at the time the option is granted? If/once the option is exercised, you agree that there is no reason to make an 83(b) election if the stock is vested? Thanks!

    • joewallin

      Yes. If you receive a stock option in a private company, you generally cannot make an 83(b) election. See
      http://www.law.cornell.edu/uscode/text/26/83

      (e) Applicability of section

      This section shall not apply to—

      (1) a transaction to which section 421 applies,

      (2) a transfer to or from a trust described in section 401 (a) or a transfer under an annuity plan which meets the requirements of section 404 (a)(2),

      (3) the transfer of an option without a readily ascertainable fair market value,

      (4) the transfer of property pursuant to the exercise of an option with a readily ascertainable fair market value at the date of grant, or

      (5) group-term life insurance to which section 79 applies.

  • http://twitter.com/margee53089 Margee Claudon

    Does this 83b election by an investor trigger SE tax? I have the following situation: a client who made an
    investment in a start up business. He is just an investor. In 2012 he received
    75 shared of non-voting common stock with the following restrictions: the stock
    is subject an an agreement under which it is forfeitable if the transferee’s
    service as an advisor to the issuer corporation terminates prior to certain
    specified dates. The FMV at time of transfer was $91,950 and he made a section
    83(b) election to “include in gross income as compensation for services
    the excess of FMV at the time of purchase over the amount paid for certain
    stock of XYZ”

    • http://startuplawblog.com/joewallin Joe Wallin

      Well, in this instance it sounds like the shares were received for services as an advisor. Not paid for in an investment transaction. If so, the tax consequences of the income would be the same if the advisor was paid in cash. The IRS will treat the FMV of the stock just like it was cash. If advisor was working as a consultant and received cash for consulting services consultant would owe income and employment taxes.

  • YMC

    Hi Joe – do you think that the IRS will accept a printed signature (a computer generated signature that looks like a handwritten signature) – like you might have with hellosign or do you think that it has to be pen to paper – ink only?

    • http://www.joewallin.com Joe Wallin

      Well, I don’t know, but why risk it?

 
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