Section 83(b) Election: Tax Benefits and How to File
A Section 83(b) Election is a provision in the Internal Revenue Code that allows taxpayers who receive restricted stock or other property subject to vesting, such as stock options or restricted stock units, to elect and include the fair market value (FMV) of the property at the time it was granted as taxable income in the year of receipt. The election allows taxpayers who receive equity compensation to pay taxes on the fair market value (FMV) at the time of granting, rather than at the time of stock vesting. The election can potentially have massive tax benefits and savings, since it allows taxpayers to pre-pay taxes on equity compensation on a low valuation.
By recognizing income earlier at the time of granting, taxpayers can pre-pay a lower tax bill on the equity compensation, assuming the equity value increases in future years.
Qualifications and Suitability for Section 83(b) Elections
Section 83(b) elections are commonly made by founders of startups, and early-stage employees of these startups since they are typically compensated via restricted stock units. These awards are typically issued at a nominal value, such as $.001 per share. If taxpayers who receive these awards made an 83(b) election, they would pay ordinary income tax on the $.001 per share nominal value, resulting in a very minimal tax bill. The taxes paid up-front would become the taxpayer’s cost basis in the shares, and the taxpayer would be subject to a capital gains tax on the FMV if the shares are sold later.
Common Examples of Equity Compensations that Taxpayers Can File an 83(b) Election For
There are various other types of equity compensations that taxpayers can file an 83(b) election for. These all have different tax implications, but if an 83(b) election is made, it can potentially save taxpayer’s a significant amount of money, since the election instructs the IRS to tax the equity compensation when it is granted at a lower fair market value, instead of waiting until it vests, when the value is expected to increase over time.
Below are some common examples of equity compensations that taxpayers can file an 83(b) election for:
- Incentive Stock Options (ISO)
- Non-Qualified Stock Options (NSO)
- Restricted Stock Awards (RSA)
- Profits Interest Units (PIU)
How to Submit a Section 83(b) Election
Section 83(b) elections must be submitted to the IRS within 30 days after issuance of the equity compensation. In addition, taxpayers who receive such compensation and want to file an 83(b) election must also submit a copy of the completed and signed election form to their employer. It is also common to include a cover letter for the IRS, though it is not a requirement. There is a lot of information you will need to provide on the election form, such as name, address, social security number, type of shares, number of shares, FMV on the date of grant or purchase etc. However, the general template of the election forms is consistent for 83(b) Elections.
Evolved has provided two templates of Section 83(b) Elections– one for an incentive unit grant, or a profits interest unit grant, and one for a common stock grant. These can be found at the end of this article.
>> Jump to 83(b) Election Template for Incentive Unit Grant / Profits Interest Grant
>> Jump to 83(b) Election Template for Common Stock Grant
Conclusion
Section 83(b) elections can have massive tax savings implications for taxpayers who receive some sort of equity compensation. By making the election, individuals can lock in the tax liability at the time of receipt, when the award’s value is lower and is expected to increase over time.
However, there are some risks and considerations. If the property decreases in value or does not vest, the individual won’t get a tax deduction for the amount included in income. It is also important to consult an experienced tax advisor or financial planner to ensure that the election aligns with one’s overall financial goals and circumstances.
Evolved is a tax compliance and advisory firm with offices in New York City, Philadelphia and Stamford, serving clients nationally throughout the US. We provide tax provision, private equity and venture capital services alongside advisory for high net-worth tax and family office tax.
83(b) ELECTION TEMPLATE
Date:
CERTIFIED MAIL NUMBER _________________________
RETURN SERVICE REQUESTED
Department of the Treasury
Internal Revenue Service
Ogden, UT 84201-00021
Re: Election Under Section 83(b) of the Internal Revenue Code
Dear Sir or Madam:
Enclosed please find an executed form of election under Section 83(b) of the Internal Revenue Code of 1986, as amended, filed with respect to an interest in [COMPANY NAME].
Also enclosed is a copy of this letter and a stamped, self-addressed envelope. Please acknowledge receipt of these materials by marking the copy when received and returning it to the undersigned.
Thank you very much for your assistance.
Very truly yours,
Signature
Taxpayer Full Name
Enclosures
PROTECTIVE ELECTION TO INCLUDE MEMBERSHIP INTEREST IN GROSS INCOME PURSUANT TO SECTION 83(b) OF THE
INTERNAL REVENUE CODE
On [DATE], the undersigned executed an incentive unit grant agreement (the “Unit Grant Agreement”) pursuant to which equity interests (the “Incentive Units”) in [COMPANY NAME] (the “Company”) were issued in connection with the provision of services by the undersigned to or for the benefit of the Company or its affiliates. Pursuant to the Unit Grant Agreement and the Limited Liability Company Agreement of the Company, dated as of [DATE] (the “LLC Agreement”), the holder of the Incentive Units is entitled to an interest in Company capital exactly equal to the amount paid or to be paid therefor and an interest in Company profits, and so the Incentive Units qualify as “profits interests” within the meaning of Revenue Procedure 93-27 as of the date that the Incentive Units are issued. If the relationship under the Unit Grant Agreement ceases, then under certain circumstances the amount that the holder of the Incentive Units will be entitled to receive as a result of a disposition of the Incentive Units may be less than the fair market value thereof. Hence, the Incentive Units are subject to a substantial risk of forfeiture.
Based on Section 83 of the Internal Revenue Code of 1986, as amended (the “Code”), the Treasury Regulations promulgated thereunder, Treasury Regulation §1.721-1(b), Proposed Treasury Regulation §1.721-1(b)(1) and Revenue Procedures 93-27 and 2001-43, the undersigned believes that neither the undersigned’s execution of the Unit Grant Agreement nor the issuance of the Incentive Units pursuant thereto is subject to the provisions of Section 83 of the Code. In the event that execution of the Unit Grant Agreement or issuance of the Incentive Units is so treated, however, the undersigned desires to have such execution or issuance taxed under the provisions of Section 83(b) of the Code at the time the undersigned executed the Unit Grant Agreement, and the Incentive Units were issued.
Therefore, pursuant to Section 83(b) of the Code and Treasury Regulation §1.83-2 promulgated thereunder, the undersigned hereby makes an election, with respect to the Incentive Units, to report as taxable income for the calendar year 2021 the excess (if any) of the value of the Incentive Units on [DATE] over the purchase price thereof.
The following information is supplied in accordance with Treasury Regulation §1.83-2(e):
- The name, taxpayer identification number, address of the undersigned, and the taxable year for which this election is being made are:
TAXPAYER’S NAME: _______________________
TAXPAYER’S SOCIAL SECURITY NUMBER: _____________________
ADDRESS: _________________________________________________
TAXABLE YEAR: ____________________________________________
- A description of the property with respect to which the election is being made: The Incentive Units, including any rights therein that the holder of such units acquired upon the execution of the Unit Grant Agreement and the LLC Agreement.
- The property was transferred to the undersigned on [DATE]
- The property is subject to the following restrictions: If the service relationship between the undersigned and the Company and its affiliates ends, then under certain circumstances the amount that the holder of the Incentive Units will be entitled to receive as a result of a disposition of the Incentive Units may be less than the fair market value thereof.
- The fair market value of the property with respect to which the election is being made, determined without regard to any lapse restrictions and in accordance with Revenue Procedure 93-27, on the date such property is transferred: [AMOUNT]
- The amount paid for such property: [AMOUNT]
The undersigned taxpayer will file this election with the Internal Revenue Service office with which taxpayer files his or her annual income tax return not later than 30 days after the date of transfer of the property. A copy of the election also will be furnished to the person for whom the services were performed. Additionally, the undersigned will include a copy of the election with his or her income tax return for the taxable year in which the property is transferred. The undersigned is the person performing the services in connection with which the property was transferred.
Dated: ____________________
_________________________
[Taxpayer Signature]
ELECTION UNDER SECTION 83(b) OF THE
INTERNAL REVENUE CODE OF 1986, AS AMENDED
The undersigned taxpayer hereby elects, pursuant to § 83(b) of the Internal Revenue Code of 1986, as amended, to include in gross income as compensation for services the excess (if any) of the fair market value of the shares described below over the amount paid for those shares.
- The name, taxpayer identification number, address of the undersigned, and the taxable year for which this election is being made are:
TAXPAYER’S NAME: ____________________________________________________
TAXPAYER’S SOCIAL SECURITY NUMBER: _________________________________
ADDRESS: ____________________________________________________________
TAXABLE YEAR: Calendar Year 20____
- The property which is the subject of this election is ____________________ shares of common stock of _______________________________________________________.
- The property was transferred to the undersigned on [DATE].
- The property is subject to the following restrictions: [Describe applicable restrictions here.]
- The fair market value of the property at the time of transfer (determined without regard to any restriction other than a nonlapse restriction as defined in § 1.83- 3(h) of the Income Tax Regulations) is: $__________________ per share x ____________________ shares = $_____________________.
- For the property transferred, the undersigned paid $_________________ per share x _______________________ shares = $_______________________
- The amount to include in gross income is $___________________. [The result of the amount reported in Item 5 minus the amount reported in Item 6.]
The undersigned taxpayer will file this election with the Internal Revenue Service office with which taxpayer files his or her annual income tax return not later than 30 days after the date of transfer of the property. A copy of the election also will be furnished to the person for whom the services were performed. Additionally, the undersigned will include a copy of the election with his or her income tax return for the taxable year in which the property is transferred. The undersigned is the person performing the services in connection with which the property was transferred.
_________________________
[Taxpayer Signature]
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