# 83(b) Election: Tax Strategy and When and Why to File

![83(b) Election](https://www.investopedia.com/thmb/VDrUV4CqCgLL_glQGiS3GYgRolg=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/83b-Election-c2a72d69945a4c47962187ec23b8d22e.jpg)

*An 83(b) election alerts the Internal Revenue Service to tax the elector for the ownership at the time of stock granting, rather than at the time of stock vesting. — Xiaojie Liu / Investopedia*

## What Is an 83(b) Election?

An 83(b) election is a provision under the Internal Revenue Code (IRC) that gives an employee, or a startup founder, the option to pay taxes on the total fair market value of [restricted stock](https://www.investopedia.com/terms/r/restrictedstock.asp) at the time of granting.

An 83(b) election lets the employee or founder prepay taxes on the restricted stock to save money.

Benefits are tax savings, particularly if the stock's value will appreciate significantly; more favorable tax treatment on future gains; and the opportunity to deduct losses if the stock's value decreases before vesting. Risks include potential tax overpayment if the stock's value falls or the company files for bankruptcy, or the employee paying for shares they never receive if they leave the firm before vesting ends. Another risk is not making an 83(b) election, which could lead to higher taxes at vesting because future appreciations are taxed as ordinary income.

Read on to understand the related processes and implications before you make your 83(b) decision.

### Key Takeaways

*   The 83(b) election allows individuals to pay taxes on the fair market value of restricted stock at grant time, not vesting time.
*   Filing an 83(b) election can lead to significant tax savings if the stock's value increases in future years.
*   The election is beneficial mainly when the reported income is small at the grant time and shares are expected to appreciate.
*   Failing to file could result in higher taxes due upon vesting, as future appreciations are taxed as ordinary income.
*   An 83(b) election can be detrimental if the company’s value drops or if the taxpayer leaves before the vesting period concludes.

## Understanding the 83(b) Election Process

The 83(b) election applies to equity that is subject to vesting, and it alerts the [Internal Revenue Service (IRS)](https://www.investopedia.com/terms/i/irs.asp) to tax the elector for the ownership at the time of granting, rather than at the time of stock vesting.

In effect, an 83(b) election means that you prepay your [tax liability](https://www.investopedia.com/terms/t/taxliability.asp) on a low valuation, assuming the equity value increases in the following years. However, if the value of the company instead declines consistently and continuously, this tax strategy would ultimately mean that you overpaid in taxes by prepaying on higher-equity valuation.

Typically, when a founder or employee gets equity as compensation, it's taxed based on its value. The tax is based on the [fair market value](https://www.investopedia.com/terms/f/fairmarketvalue.asp) of the equity at the time of grant, minus the cost to exercise or buy the shares. The tax must be paid in the year the stock is issued or transferred.

However, in many cases, the individual receives equity vesting over several years. Employees earn company shares as they stay employed. In that case, the tax on the equity value is due at the time of vesting. If the company's value grows during the vesting period, taxes will rise each year accordingly.  

## Step-by-Step Guide to Filing an 83(b) Election

### 1\. Prepare Your Filing Document

*   Include taxpayer's name, address, Social Security number, and details of awarded shares.
*   Specify the calendar year and date of transfer, and note any restrictions.
*   Calculate and include the fair market value and amount paid for shares.  
    

### 2\. Mail the Document

Date, sign, and send the document to the IRS within 30 days of the restricted shares issuance. Use the appropriate IRS Service Center where you file your taxes.  

### 3\. Notify Your Employer

Provide a copy of the election form to your employer to ensure compliance.  

### 4\. Include in Tax Return

Attach a copy of the election with your income tax return for the year when the restricted stock was transferred.  

## Illustrative Scenarios: With and Without an 83(b) Election

### With an 83(b) Election

Let's say a co-founder of a company is granted 1 million shares subject to vesting and valued at $0.001 at the time the shares are granted. At this time, the shares are worth the [par value](https://www.investopedia.com/terms/p/parvalue.asp) of $0.001 × number of shares, or $1,000, which the co-founder pays. The shares represent a 10% ownership of the firm for the co-founder and will be vested over a period of five years, which means that they will receive 200,000 shares every year for five years. In each of the five vested years, they will have to pay tax on the fair market value of the 200,000 shares vested. 

If the total value of the company’s equity increases to $100,000, then the co-founder’s 10% value increases to $10,000 from $1,000. The co-founder's tax liability for year 1 will be deduced from ($10,000 - $1,000) × 20%; i.e., in effect, ($100,000 - $10,000) × 10% × 20% = $1,800.

*   $100,000 is the Year 1 value of the firm
*   $10,000 is the value of the firm at inception or the book value
*   10% is the ownership stake of the co-founder
*   20% represents the five-year vesting period for the co-founder's 1 million shares (200,000 shares/1 million shares)

If, in year 2, the stock value increases further to $500,000, then the co-founder's taxes will be ($500,000 - $10,000) × 10% × 20% = $9,800. By year 3, the value goes up to $1 million and the tax liability will be assessed from ($1 million - $10,000) × 10% × 20% = $19,800. Of course, if the total value of equity keeps climbing in Year 4 and Year 5, the co-founder’s additional taxable income will also increase for each of the years.

If at a later time, all the shares sell for a profit, the co-founder will be subject to a [capital gains tax](https://www.investopedia.com/terms/c/capital_gains_tax.asp) on their gains from the proceeds of the sale.

### Without an 83(b) Election

Now let's say that the co-founder decides instead not to pay taxes on the restricted stock before it begins to vest. In that case, they will be paying taxes on the shares at the end of the vesting period, five years later. If those million shares are now trading at $2 a share, they will be worth $2 million upon vesting. The co-founder will have to report that amount as ordinary income, minus the $1,000 they paid at the time the shares were granted, paying the highest possible tax rate on the entire gain during the vesting period.

> **Important**
>
> For restricted stock, you must file your 83(b) election within 30 days of receiving your shares. For stock options, you must file 83(b) within 30 days of exercising your options.

## 83(b) Election Tax Strategy

The 83(b) election gives the co-founder the option to pay taxes on the equity upfront before the vesting period starts. This tax strategy allows the co-founder to only pay taxes on the fair market value of the shares, minus the cost of exercising the options. If the fair market value of the shares is equal to their [strike price](https://www.investopedia.com/terms/s/strikeprice.asp), the taxable gain is zero.

The 83(b) election notifies the IRS that the elector has opted to report the difference between the amount paid for the stock and the fair market value of the stock as taxable income. The share value during the five-year [vesting](https://www.investopedia.com/terms/v/vesting.asp) period will not matter as the co-founder won’t pay any additional tax and gets to retain the vested shares. However, if the shares are sold for a profit, a capital gains tax will be applied. 

Following our example above, if the co-founder makes an 83(b) election to pay tax on the value of the stock upon issuance, the [tax assessment](https://www.investopedia.com/terms/a/assessedvalue.asp) will be made on the difference between the shares' strike price and their [fair market value](https://www.investopedia.com/terms/f/fairmarketvalue.asp).

If the stock is sold after, say, 10 years for $250,000, the taxable capital gain will be on $249,000 ($250,000 - $1,000 = $249,000).

The 83(b) election makes the most sense when the elector is sure that the value of the shares is going to increase over the coming years. Also, if the amount of income reported is small at the time of granting, an 83(b) election might be beneficial.

In a reverse scenario where the 83(b) election was triggered, and the equity value falls or the company files for bankruptcy, then the taxpayer overpaid in taxes for shares with a lesser or worthless amount. Unfortunately, the IRS does not allow an overpayment claim of taxes under the 83(b) election. For example, consider an employee whose total tax liability upfront after filing for an 83(b) election is $50,000. Since the vested stock proceeds to decline over a four-year vesting period, they would have been better off without the 83(b) election, paying an annual tax on the reduced value of the vested equity for each of the four years, assuming the decline is significant.

Another instance where an 83(b) election would turn out to be a disadvantage will be if the employee leaves the firm before the vesting period is over. In this case, they would have paid taxes on shares that would never be received. Also, if the amount of reported income is substantial at the time of stock granting, filing for an 83(b) election will not make much sense.

## Advantages of Choosing an 83(b) Election

The 83(b) election has major benefits for those [receiving restricted stock](https://www.investopedia.com/articles/financial-advisors/110915/restricted-stock-units-what-know.asp) or property. They can pay taxes upfront on the property's fair market value at the time of grant, potentially lowering the rate compared to when it vests. This upfront taxation can lead to tax savings, especially if the property's value is expected to appreciate significantly.

Furthermore, making the election allows for more favorable tax treatment on future gains, taxing appreciation at the lower capital gains rate rather than ordinary income. Additionally, individuals who make the 83(b) election may have the opportunity to deduct losses if the property's value decreases before vesting, providing a level of tax flexibility and protection.

Overall, the 83(b) election provides a strategy for managing tax liabilities and optimizing tax treatment for restricted property recipients.

## When Is It Beneficial to File an 83(b) Election?

An 83(b) election allows for the prepayment of the tax liability on the total fair market value of the restricted stock at the time of granting. It is beneficial only if the restricted stock's value increases in the subsequent years. Also, if the amount of income reported is small at the time of granting, an 83(b) election might be beneficial.

## What Happens If You Don't Make an 83(b) Election?

Failing to make an 83(b) election can have significant tax consequences for individuals who receive restricted stock or other property subject to vesting. When restricted stock or property vests, you'll be taxed on its value as ordinary income at that time, potentially resulting in higher taxes. Without the election, any future appreciation in the property's value will be subject to capital gains tax upon sale, possibly leading to less favorable tax treatment overall.

## When Is It Detrimental to File an 83(b) Election?

If an 83(b) election was filed with the IRS and the equity value falls or the company files for bankruptcy, then the taxpayer overpaid in taxes for shares with a lesser or worthless amount. Unfortunately, the IRS does not allow an overpayment claim of taxes under the 83(b) election.  

Another instance is if the employee leaves the firm before the vesting period is over; then the filing of an 83(b) election would turn out to be a disadvantage as they would have paid taxes on shares they would never receive. Also, if the amount of reported income is substantial at the time of the stock granting, filing for an 83(b) election will not make much sense.

## What Is Profits Interest?

Profits interest refers to an equity right based on the future value of a partnership awarded to an individual for their service to the partnership. The award consists of receiving a percentage of profits from a partnership without having to contribute capital. In effect, it is a form of equity compensation and is used as a means of incentivizing employees when monetary compensation may be difficult due to limited funds, such as with a startup limited liability company (LLC). Usually, this type of worker compensation requires an 83(b) election.

## The Bottom Line

An 83(b) election is a strategic, tax-related decision primarily used by startup founders and employees to manage future tax liabilities on restricted stock. It involves paying taxes upfront on the fair market value of the stock at the time of granting, which can be beneficial if the stock's value increases over time.

An 83(b) election allows the stock owner to take advantage of lower long-term capital gains tax rates rather than higher ordinary [income tax](https://www.investopedia.com/terms/i/incometax.asp) rates, which apply if the stock increases in value and is later sold.

While an 83(b) election provides tax benefits if the stock appreciates, it may lead to overpayment if the stock depreciates or is never fully vested, such as if an employee leaves the company early.

To take advantage of the benefits, it is important to file the 83(b) election form within 30 days of being granted the stock.

Consider your financial situation and the company's future outlook before opting for an 83(b) election, due to its potential risks and benefits.

_**Correction—June 14, 2023:**_ An older version of this article incorrectly stated that someone making an 83(b) election would be taxed according to the cost of exercising their shares. In fact, the tax is based on the difference between the fair market value of the shares and the exercise price.

> **Article Sources**
>
> 1.  Internal Revenue Service. "[26 CFR 1.83-2: Election to Include in Gross Income in Year of Transfer](https://www.irs.gov/pub/irs-drop/rp-12-29.pdf)." Pages 1-3.
>     
> 2.  Internal Revenue Service. "[26 CFR 1.83-2: Election to Include in Gross Income in Year of Transfer](https://www.irs.gov/pub/irs-drop/rp-12-29.pdf)." Pages 1-6.
>     
> 3.  Internal Revenue Service. "[Topic No. 427, Stock Options](https://www.irs.gov/taxtopics/tc427)."
>     
> 4.  Fidelity. "[Instructions for Completing IRS Section 83(b) Form](https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/customer-service/instructions-for-completing-irs-section-83b.pdf)."
>     
> 5.  Internal Revenue Service. "[26 CFR 1.83-2: Election to Include Gross Income in Year of Transfer](https://www.irs.gov/pub/irs-drop/rp-12-29.pdf)."
>     
> 6.  Internal Revenue Service. "[26 CFR 1.83-2: Election to include in gross income in year of transfer](https://www.irs.gov/pub/irs-drop/rp-12-29.pdf)." Page 6.
>     
> 7.  Internal Revenue Service. "[Topic No. 409, Capital Gains and Losses](https://www.irs.gov/taxtopics/tc409)."
>     
> 8.  JPMorgan Chase. "[Stock-Based Compensation and the 83(b) Election](https://www.jpmorgan.com/wealth-management/wealth-partners/insights/stock-based-compensation)."