Section 83(b) is an election that allows a taxpayer to “elect” to treat unvested or restricted property as fully vested for tax purposes and pay the tax at grant rather than at time of vesting – and starts the holding period for long-term capital gains. By accelerating the timing of the taxation, the taxpayer is “betting” that they will (a) meet the conditions of vesting and (b) the property will increase significantly in value. If these two events happen, the taxpayer will be able to capture tax significant tax savings because of the lower tax rates on long-term capital gains.
Vested or Unrestricted Property
The fair market value of the property is included in the income of the service provider (as ordinary income) at the time of grant. The taxpayer’s holding period for long-term capital gains begins immediately.
Rule for Unvested or Restricted Property
Subject to a “Substantial Risk of Forfeiture”
The fair market value of the property is NOT included in the income of the service provider at the time of grant. Instead, the taxpayer includes the fair market value of the property at the time of vesting . The taxpayer’s holding period for long-term capital gains begins on each separate block of property as it vests.
Section 83(b) Election
Within 30 days of grant (the election MUST be made within 30 days of grant), the taxpayer can file an election with the Internal Revenue Service to treat the unvested/restricted property as vested immediately at the time of grant. The taxpayer must include the fair market value of the property in income and pay the corresponding tax.
Assume Executive A and Executive B are both granted 100 shares of stock in the company on January 1, 2020, when the stock is currently valued at $5/share. Executive A’s stock is not subject to any restrictions. Executive B’s stock vests annually over 5 years in equal installments. Assume the stock increases $5 in value each year. Both executives sell their stock for $40/share on January 2, 2025. Further assume the blended federal and state income tax rates for ordinary compensation income is 40% and for long term capital gains is 25%.
|Executive A||Executive B|
|January 1, 2020||100 x $5 = $500 x 40% = $200 tax||$0|
|January 1, 2021||$0||20 x $10 = 200 x 40% = $80 tax|
|January 1, 2022||$0||20 x $15 = $300 x 40% = $120 tax|
|January 1, 2023||$0||20 x $20 = $400 x 40% = $160 tax|
|January 1, 2024||$0||20 x $25 = $500 x 40% = $200 tax|
|January 1, 2025||$0||20 x $30 = $600 x 40% = $240 tax|
|January 2, 2025||$4,000 - $500 (basis) = $3,500 gain $3,500 gain x 25% = $875 tax||$3,200 - $1400 (basis) = $1,800 long-term gain $1,800 gain x 25% = $450 tax $800 – $600 (basis) = $200 short-term gain* $200 gain x 40% = $80 tax|
|Total Tax Paid||$200 (grant) + $875 (sale) = $1,075||$0 grant + $800 (vesting) + $530 (sale) = $1,330|
* the shares that vested on January 1, 2025 do not meet the one year holding period for long-term capital gains.
Section 83(b) allows Executive B to “elect” (MUST be within 30 days of grant) to treat the shares as vested/ unrestricted at the time of grant for tax purposes. She would include $500 of income at the time of grant, pay the $200 tax and begin her holding period for long-term capital gains on all of the shares. At sale, she would be taxed in the same manner as Executive A.
Note: In addition to paying the tax immediately, there is no ability to claim a loss if she does not meet the vesting requirements and has to forfeit any portion of the stock. Also, the “tax benefit” demonstrated above ONLY applies if the stock is appreciating in value. If the stock stays flat or depreciates in value, then there is no benefit and the taxpayer has only accelerated the timing of her income inclusion. Thus, a taxpayer should consider avoiding Section 83(b) inclusion when they believe they may not meet the vesting requirements and/or the property may not appreciate in value – especially if the current inclusion of income is significant. However, if the current inclusion is minimal (because the property has little or no value at the time of grant), then a Section 83(b) election may be a very good bet, regardless.