Many employees see the value in company stock, especially recently. The average worker participation rate in employee stock purchase plans rose to 28% from January 2020 to March 2021.
And purchasing stocks isn’t employees’ only option. Many companies offer their team members a chance to earn vested stock, whether it’s through meeting certain commitments or staying with the company for a certain number of years.
Upon receiving these stocks, employees – and start-up founders who give themselves company stocks – have a few choices.
They can either decide to file taxes on these stocks right away with an 83(b) form or wait to file taxes once the stocks are fully transferred over to them once commitments are met.
The 83(b) form is an option created by the IRS that allows employees and start-up founders to pay taxes on vested stock now, with the hopes of paying less in taxes later.
We’ve created the following guide explaining what an 83(b) form is in detail, the importance of filing it, and an example of the tax impact.
What Is Form 83(b)?
The 83(b) election is an option granted by the Internal Revenue Service (IRS) that allows an employee or startup founder to pay taxes on the total fair market value of the restricted stock when it is granted.
Restricted stock are shares that have been issued to an employee as part of their pay, but the stocks won’t be fully transferred to that individual until after certain conditions have been met. For example, the stock could be available after a certain number of years or after certain payments have been made.
The 83(b) alerts the IRS to tax the elector for that income at the time of granting, instead of when the stock vests. The election applies only to the equity that is subject to vesting.
Where to Send Form 83(b)
To make an 83(b) election, you must complete the following steps within 30 days of being granted the stock.
First, complete the IRS 83(b) form.
Next, mail the completed form to the IRS within 30 days of being granted the stock options. Send the form to the IRS Service Center where you file your taxes.
Lastly, mail a copy of the completed form to your employer.
When you file your income taxes that year, you must also attach a copy of the completed form to your income tax return.
Benefits of Filing an 83(b)
An 83(b) allows the earner to pay for the pre-payment tax liability on the fair market value of the restricted stock at the time it was given to the earner.
Say that a new member of a company receives restricted stock that will vest in 2 years. With an 83(b), they could report the income on their earnings for this year and pay taxes during that time. If the stock’s value increases in those next 2 years, the employee would save significantly on taxes and therefore net higher gains.
Times Not to File an 83(b)
The same logic applies when considering the drawbacks of filing an 83(b). Say an 83(b) election was filed with the IRS, but the equity value falls or the company files for bankruptcy.
In this case, the taxpayer overpaid in taxes for shares that ultimately are not worth the amount of taxes. The earner will have paid taxes for earnings that never materialized.
Unfortunately, the IRS does not allow an overpayment claim of taxes with the 83(b) election form. Once you make the payment, the money is no longer yours. Those who are risk-averse therefore may choose not to elect an 83(b).
Firm 30 Day Filing Deadline
For an 83(b) to be elective, the option holder has to file the election within 30 days of being granted the stock. There are no exceptions to this rule.
The last possible day for filing is calculated by counting every day after the date the stock is granted. This includes Saturdays, Sundays, and holidays.
So, if you’re granted a restricted stock on April 10, you have until May 10 to file the 83(b). The postmark on the date of mailing is the date of filing.
Failing to File an 83(b)
What if you don’t file an 83(b) election on qualifying stock within the deadline? Under tax rules, you will be taxed on the fair market value of the stock only when it becomes vested (meaning that it no longer is under the rights of the company).
For example, the stock would be vested when the employee meets the time commitment of working at the company.
On the vesting date, the fair market value of the shares that have vested will be treated as compensation income. They will be subject to ordinary income tax and employment tax withholding.
Say that the value of the restricted stock goes up between the granted date and the vesting date. Both the original value and the increase in the value of the shares will be treated as compensation income.
Essentially, the amount of compensation from the vested shares will be reported on your W-2 for each year. The company will withhold the taxes on the income until the stock is transferred completely to you.
Example of 83(b) Election
Mark gets a job with the 123 Corporation. The company wants to motivate Mark, so they offer Mark non-vested stock options.
They will vest in five years – meaning that he will not have access to the stock for at least 5 years of working with the company. Mark will only gain access to them after he proves that he is a long-term employee.
The company is fairly new and stock options are worth just $0.10 each. Mark receives 20,000 shares.
In the meantime, Mark can choose how he wishes to handle paying taxes for the unearned stock. As of right now, the stock is worth $2000.
Elect 83(b) Tax Liability?
With 83(b), Michelle would claim the $2000 on this year’s tax return and pay taxes on those earnings now. The main reason Mark would do this is that he hopes the company would exponentially increase in value.
As the company’s value increases, so would the value of her shares. But because she already paid tax on the shares earlier, she would not have to pay the taxes later and would achieve higher capital gains.
83(b) Election Analysis
In five years from now, when Mark earns the stock, it is worth $2.50 a share. In the sixth year, Mark decides to sell the stock for the $2.50 price a share.
Mark will then pay long-term capital gain on the additional money that he received.
30% tax on $0.10 per share of ordinary income per share when received
15% on long-term capital gain
Income = $50,000 – $1000 in basis = $49,000 in long-term capital gain
Total tax due = $49,000 * 15% = $7350
*For the purpose of this analysis, we are assuming that mark’s net-effective tax rate is 30% and his long-term capital gain rate is 15%.
No 83(b) Election Analysis
Say that Mark waited to pay the income tax until the stock vested. He did not want to pay tax on income that he wasn’t entirely sure he would earn.
When the company does well, Mark’s tax base looks very different.
30% tax on $2.50 per share of ordinary income
15% tax on $2.50 per share of long-term capital gain
Income = $50,000, taxed at 30%
Total tax due = $50,000 * 30% = $15,000
In this scenario, Mark will end up paying a much higher amount in taxes because he waited for the stock to vest. Most of his earnings will be taxed as ordinary income rather than capital gains.
ISOs vs. NSOs
One important distinction to make is between ISOs and NSOs.
ISOs can only be granted to employees, while NSOS can be granted to employees, independent contractors, and directors. Each type of stock option functions differently with the 83(b).
Non-Qualified Stock Options (NSOs)
NSOs don’t qualify for ISO treatments and are the simpler form of the two stock options listed.
Taxation on NSOs happens when they’re exercised. NSOs will always be taxed at the ordinary income tax rate. So, if you refer back to the example above, the benefits that you would gain from filing the 83(b) and only paying taxes on long-term capital gains would not apply for NSOs.
Therefore, it is not possible to file an 83(b) election for NSOs (which is why they have the name “non-qualified”).
However, you may be able to qualify for long-term capital gains treatment on stock purchased for NSO. You will have had to hold the stock for at least one year after purchase, and the stock must have come from options granted more than two years before the sale.
Qualified Stock Options (ISOs)
Qualified stock options are ISOs and may only be offered to employees. They expire 10 years after their issues and typically come with a vesting schedule.
ISOS are eligible for the 83b tax form, meaning that you have the choice to pay taxes now rather than later. The previous explanations and examples in this article qualify for ISOs.
Completing the 83(b) Form
The 83(b) form is just one of the ways for employees and start-ups to be strategic about their earnings. For more tips, visit the Pasquesi Partners blog or contact us!