What is a Section 83(b) election?

A person who purchases or otherwise receives shares of restricted stock (including unvested stock that is purchased through the early exercise of an option) is generally taxed when the shares vest, but he or she may instead choose to be immediately taxed by filing a Section 83(b) election with the IRS within 30 days after receiving the shares.

A Section 83(b) election causes the stock to be treated as vested on the date of transfer meaning:

• The recipient of the restricted stock recognizes ordinary income equal to the excess if any, of the fair market value of the shares over the exercise or purchase price paid for the shares, if any (the spread) on the date of transfer
• Your company is generally entitled to a deduction equal to the amount of ordinary income recognized by the recipient
• The company has a withholding obligation for income and employment taxes based on the spread, if any, on the date of transfer, if the recipient is an employee
• The recipient’s capital gain holding period begins at the time of the transfer
• Any later increase in the value of the shares will not be taxed until the shares are sold and will be taxed as capital gain

The potential downside to making a Section 83(b) election is if the restricted stock does not vest and is forfeited or repurchased at cost by the company, the recipient will not receive a tax credit or a tax deduction for any taxes he or she already paid. From the company’s perspective, if the value of the stock increases after the election is made, the company has lost the benefit of a higher deduction.

For early-exercised incentive stock options, a Section 83(b) election is available only for alternative minimum tax purposes, and the election will not start the 12-month clock for long-term capital gain treatment. Please see the related article on the U.S. federal tax effects of early exercising an incentive stock option.

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