A section 83(b) election allows employees with Restricted Stock Units (RSUs) to pay taxes in advance. If you do not opt for an 83(b) election with RSUs, you simply pay ordinary income as your shares vest every year (See our blog “Restricted Stock Units” for reference). Depending on your company’s plan, vesting could take place over several years (graduated vesting) or all shares could vest in one year (cliff vesting).
Let’s take a deeper look at the pros and cons of an 83(b) election:
By making an 83(b) election, you are paying taxes on shares that you do not own yet. Ideally, your tax liability will be less when you make the election than when the shares fully vest. After vesting, you will not owe anything because you “pre-paid” the taxes when you were granted the shares. At that point, any stock price increases above the grant price will be subject to long-term capital gains (as opposed to ordinary income). Note that you only pay capital gains if you sell the stock.
By pre-paying tax on shares that are not yet yours, leaving the company before satisfying the vesting requirements can have negative consequences. In addition to not receiving the shares, you also lose the taxes you paid in the year the section 83(b) election was made.
There is also risk if the stock price declines steadily after the grant date. Since the tax liability is based on the value of the stock at the time it’s granted, this would lead to a higher tax bill. In this example, it would have been better to not elect a section 83(b) and to pay ordinary income as the shares vest. The IRS does allow you to take a capital loss if the sale price is less than the price at your time of grant (limited to $3,000 per year on your individual tax return). If you are granted 1,000 shares of X Corp. with a grant price of $20, make an 83(b) election and ultimately sell the stock at $18 per share, you are allowed to take a capital loss of $2,000.
Let’s assume that you start a new job with ABC Corporation. As part of your compensation package, the company grants you 100 Restricted Stock Units. The RSUs are subject to a 4-year vesting period and shares are currently valued at $50 apiece. You will receive 25 shares each year you remain employed. You believe the stock is currently undervalued and that future growth will increase the stock price. You decide to pre-pay the taxes by submitting a section 83(b) election to the IRS on the 100 shares.
As you predicted, the share price continues to climb: in year one it is $60, in year two it is $90, in year three it is $110, and in year four it is $160. Assuming a 32% ordinary income rate and a 15% long-term capital gains rate, let’s review the calculations to see the difference between making/not making an 83(b) election.
Under 83(b) Election
100 granted shares x $50 per share at grant = $5,000 of ordinary income
$5,000 x 32% = $1,600 tax liability
No 83(b) Election is made
$480 + $720 + $880+ $1,280 = $3,360 tax liability
In this example, electing a section 83(b) election saves you $1,760 in ordinary income taxes!
How do you make a section 83(b) election?
If you decide to pre-pay the taxes when you are granted shares, we recommend speaking with your company’s HR department to obtain the form and consult with your tax professional. Typically, you must elect an 83(b) election within 30 days of the RSU grant. We recommend making three copies of the completed election form: one for your records, one for your company, and one for the IRS. It’s a good idea to send the election form to the IRS via certified mail, request a return receipt, and to include the certified mail number on an attached cover letter. This will be proof that the IRS received it within the 30 day window.
Section 83(b) elections can provide large tax savings for individuals working for high-growth companies. Pre-paying taxes can pay off later if your company’s stock price increases for several years. We always recommend that you speak with your tax accountant and financial advisor before making a decision that impacts your financial future.
If you have any questions, please reach out to our team here at Taylor Hoffman!
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