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Tech Company Compensation: Unraveling the Mystery of the 83(b) Election
By Robert Gosart, CPA | Director - Tax
Most technology companies offer stock-based compensation. If you are an employee that can benefit from a company that does, you probably have heard of the 83(b) election.
The basic premise of Internal Revenue Code Section 83 is simple. It states that if you receive property in exchange for services, the difference between the value of the property received (stock), and what you paid for it, if anything, is taxable income (generally wages). However, if you receive the stock subject to a restriction (like a vesting schedule), then the taxable event occurs later when the restriction lapses (when the stock becomes vested). Any change in the stock’s value during this time will either increase or decrease the taxable event when the restriction lapses.
This is when Section 83(b) can be utilized to your benefit or detriment. If you think the value of the stock will increase while you wait, which most people do, then 83(b) allows you to accelerate the taxable event and include the income on the earlier exercise date, before the date of restriction lapses. When the restriction lapses, there is no taxable event, and any appreciation in the stock from the exercise date is a capital gain. If held for more than a year, it is taxed at the lower long-term capital gains rate when sold. The detriment is if the stock goes down, then you have a capital loss that can be deducted only to the extent of capital gains. The employee gets no refund of taxes paid on the earlier exercise date.
The 83(b) election is made by mailing the IRS a signed statement within 30 days of the date the restricted property is received. A copy should also be attached to the employee’s tax return for the tax year when the election is made.
The most common forms of stock-based compensation are restricted stock awards (RSAs), restricted stock units (RSUs), nonqualified stock options (NSOs), and incentive stock options (ISOs).
THIS IS HOW SECTION 83(B) APPLIES TO EACH ONE:
RSAs: These are shares of stock that an employer transfers to an employee (the grant date), usually at no cost, subject to a vesting schedule. The default taxable event is the value of the shares on the later vesting date when the vesting
restriction lapses. The employee can make an 83(b) election and accelerate the taxable event to the grant date if he or she thinks the stock will substantially appreciate.
RSUs: These are a promise from the employer to deliver stock or cash to the employee in the future, based on the stock's performance. RSUs are not considered property and therefore are not governed by Section 83. Thus, there are no tax implications when employers grant RSUs and no Section 83(b) election is available.
NSOs: These are stock options awarded to employees, not according to a plan that meets specific requirements laid out in the Internal Revenue Code. Because most compensatory NSOs do not have a readily ascertainable fair market value (FMV), they are not eligible for an 83(b) election. The taxable event does not occur on the grant date, but on the later exercise date, where 100% of the income is wages. However, if the stock acquired upon exercise of the option is restricted, then it would be eligible for an 83(b) election at that time.
ISOs: These are stock options awarded to employees according to a plan that meets specific requirements laid out in the Internal Revenue Code. There is no taxable compensation when ISO shares are transferred to an employee, and 100% of the stock's appreciation is taxed to the employee as a capital gain when the stock is sold. Thus, no section 83(b) election is available.
New Section 83(i), enacted as part of the 2017 Tax Cuts & Jobs Act, allows employees of certain privately held companies to elect to defer the payment of income taxes on certain equity compensation for up to five years. An 83(b) election is not applicable to this type of stock compensation.
Finally, with the exception of ISOs, all of the above-mentioned equity awards and 83(b) elections are available to independent contractors.
1 Edwards, Vlada, CPA (2019, May 1). Stock-based compensation: Back to basics. Tax Advisor. https://www.thetaxadviser.com/ issues/2019/may/stock-based-compensation-basics.html 2 Internal Revenue Service (2018, December 7). Guidance on the Application of Section 83(i). https://www.irs.gov/pub/irsdrop/n-18-97.pdf 3 Davis Polk (2018, December 12). First Guidance on the Application of Section 83(i) – Tax Deferral for Private Corporation Equity Compensation Awards. Memo. https://www.davispolk.com/publications/ first-guidance-application-section-83i-tax-deferral-private-corporation-equity
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