Form 83(b) is a form that is signed and sent to the Internal Revenue Service (“IRS”) making a choice — an election — on when the signatory would like to be taxed on future-vesting equity, like shares stock, issued by a corporate entity. By sending Form 83(b), the signatory chooses to have the equity taxed during the tax year when the equity was granted. Form 83(b) must be sent within 30 days of the equity grant. If Form 83(b) is not sent within those 30 days, then the grantee is taxed in the tax year when the equity vests.
Whether to make a Form 83(b) election depends on several factors including the value of the equity at the time of the grant, the expected value of the equity at the time of vesting, the cash-liquidity of the taxpayer at both times and the expected value and potential saleability of the equity at some future date. These variables matter because the value of the equity at the time of granting (or vesting) will be taxed as ordinary income, but any appreciated value of the equity will be taxed later as capital gains. Currently, the top tax rate for ordinary income is 37%, while the long-term capital gains rate remains at 20%. Note further that the tax on the value of the equity grant will be assessed regardless of the fact that the equity is or might be sale-restricted and might not be easily converted into cash.
For these reasons, many choose to make the Form 83(b) election at the time the equity is granted. But not always.
As a simple example, assume that the taxpayer receives a grant of 100,000 shares of stock which will vest in two years and which cannot be sold for a year after vesting. At the time of the grant, the value of the shares is 1¢. The shares are expected to be worth $1.00 in two years and, hopefully, worth $2.00 at the three year mark. At the time of the grant, the value of the stock is $1,000 — 100,000 times 1¢. If Form 83(b) is filed within 30 days of the grant, then the taxpayer will be taxed in that tax year on $1,000 in value at the ordinary income rate for an extra tax of $370 (assuming the top rate). By contrast, if Form 83(b) is NOT sent, then in two years, the taxpayer will be taxed on the value of the stock at the time of vestiture. If expectations were met and the value of the stock has risen to $1.00, then the value of the stock will be $100,000 and the taxpayer will be taxed on that value, in that tax year, at the ordinary income rate. That would be a tax liability of $37,000 (assuming the top rate). Note, again, that the tax is assessed regardless of the fact that, in our example, the equity was not sold and cannot be sold for another year. This shows why many choose to make the Form 83(b) election at the time the equity is granted.
For purposes of a taxpayer’s ability to PAY the tax, it might be as simple as saying a tax liability of $370 vs. $37,000. But, to see the overall tax consequences, we must include the capital gains tax. Capital gains tax is calculated from the initial tax valuation. So, if 100,000 shares are granted and then Form 83(b) is filed, the 100,000 shares are taxed at 1¢ and, therefore, have an initial capital gains value of $1,000. Assuming expectations have been met, at the year-two mark, the shares have increased in total value by $99,000. If sold at the two-year mark, that would result in a long term capital gains tax on that $99,000 at 20% which would result in a tax liability of $19,800. So, the proper comparison is $370 + $19,800 vs. $37,000. (Of course, there is no capital gains tax liability until the 100,000 shares are sold.) In our hypothetical, even considering the capital gains tax implications, it is clearly better to make the 83(b) election.
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