Do I have to make a Section 83(b) election?

Q&AQ:   I just exercised a vested stock option.  Do I now have to make a Section 83(b) election?

A:   No, unless your company’s stock option plan documents contain unusual or atypical provisions.  Typically you do not have to make a Section 83(b) election on shares you acquire upon the exercise of a vested stock option.  (The same is not true for the exercise of an immediately exercisable stock option, which allows an optionee to exercise an option and acquire unvested shares.)

The reason you don’t have to make an 83(b) election on the exercise of a vested stock option is because the shares acquired, being vested, are not subject to a substantial risk of forfeiture under Section 83 of the Internal Revenue Code.

Section 83(a) says the following:

“Substantial risk of forfeiture” – The rights of a person in property are subject to a substantial risk of forfeiture if such person’s rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual.

    If, in the connection with the performance of services, property is transferred to any person other than for whom such services are performed, the excess of –
  1. the fair market value of such property (determined without regard to any restriction other than a restriction which by its terms will never lapse) at the first time the rights of a person having the beneficial interest in such property are transferrable or are not subject to a substantial risk of forfeiture, whichever occurs earlier over the amount (if any) paid for such property,
  2. shall be included in the gross income of the person who performed such services in the first taxable year in which the rights of the person having the beneficial interest in such property are transferable or not subject to a substantial risk of forfeiture, whichever is applicable.

The regulations add a little detail to this. For example, the regulations provide that “[p]roperty is not transferred subject to a substantial risk of forfeiture to the extent that the employer is required to pay the fair market value of a portion of such property to the employee upon the return of such property.”

In general, the answer to this question is found in the statute itself, in the provisions quoted above.

Conclusion

If you are exercising a vested option, consult with your tax advisors to confirm, but a Section 83(b) election should not be required.

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About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.
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