I Filed an 83(b) and Don't Understand: What It Means, Tax Return, When Do I Pay?

Someone on Reddit had just joined a startup, filed an 83(b) election for restricted stock (or similar equity), and still did not understand what it meant. They asked for an ELI5, whether the 83(b) goes on their tax return now, whether they attach a copy to their return, and whether they pay taxes after they vest and cash out. With an 83(b), you are taxed in the year of grant on the fair market value at grant as ordinary income; you do not pay ordinary income again when the stock vests. You do report that income and attach a copy of the 83(b) to your return for the year you received the stock. When you sell, you pay capital gains tax on the appreciation from grant to sale.

Bottom line: An 83(b) election means you chose to be taxed at grant on the value of the stock at grant (ordinary income). Yes, that income goes on your tax return for the year you made the election (the year you received the stock), and yes, you attach a copy of the 83(b) to that return. You pay ordinary income tax now (for the year of grant), not only "after you vest and cash out." When the stock vests, you do not pay ordinary income again. When you sell, you pay capital gains tax on the gain (sale price minus value at grant). For exact reporting and FMV at grant, consult a tax professional.

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Question from Reddit

Filed an 83b but don't understand what that means

I just joined a start up and filed an 83b election. I've been reading about it but it doesn't make sense to me. Can someone ELI5? Also will this go on my tax return now? I believe I just attach a copy to my return? And then pay taxes after I vest and cash out?

Source: Reddit

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Analysis

The user filed an 83(b) election when they received restricted stock (or similar equity) at a startup and wants a simple explanation of what it means and when they pay tax. They are incorrect that they "pay taxes after I vest and cash out." With an 83(b), you pay ordinary income tax in the year of grant (when you made the election) on the fair market value at grant; you do not pay ordinary income again when it vests; you pay capital gains tax when you sell (on the appreciation from grant to sale). They are correct that they attach a copy of the 83(b) to their tax return for the year of the election (the year of grant) and that the income from the 83(b) goes on that return now.

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Answer

ELI5: What does filing an 83(b) mean?

• You got restricted stock (or similar equity) from your startup. It vests over time, meaning you don't fully "own" it until certain dates.
• Without an 83(b): The IRS taxes you when each piece vests, on the value of that piece on the vesting date. If the company grows, that value can be much higher than when you got it, so you'd owe more ordinary income tax over the vesting years.
• With an 83(b): You told the IRS: "Tax me now on the value when I got it (at grant), not when it vests." So you pay ordinary income tax once, in the year you received the stock, on the value at grant. When it vests, you don't pay ordinary income again on that stock. When you later sell, you only pay capital gains tax on the growth from grant to sale (often at long-term rates if you hold long enough).
• Why people do it: If the stock was worth little or nothing at grant (common at startups), you lock in low or $0 ordinary income now and turn all the future growth into capital gain instead of ordinary income. That can save a lot of tax if the company does well.

Will this go on my tax return now?

• Yes. The income from the 83(b) goes on your tax return for the year you made the election, that's the year you received the stock (the year of grant). So for this year's return (the year you joined and filed the 83(b)), you include the fair market value of the stock at grant as ordinary income. You report it on your Form 1040 (the amount is typically included in wages or other income depending on how your employer reports it, or you report it as compensation from the 83(b) per the instructions). So you do pay tax now (for the year of grant), not "after you vest and cash out."

Do I attach a copy to my return?

• Yes. You attach a copy of the 83(b) election you sent to the IRS (and to your employer) to your Form 1040 for the year of the election (the year of grant). The IRS instructions say to file the election with the IRS within 30 days of the transfer (you already did that) and to attach a copy to your tax return for the taxable year in which the transfer occurred. So when you file your return for the year you got the stock, attach the copy there.

And then pay taxes after I vest and cash out?

• Not quite. You already pay ordinary income tax in the year of grant (on the value at grant). That's now, on this year's return. You do not pay ordinary income tax again when the shares vest.
• When you cash out (sell the shares), you pay capital gains tax on the gain = sale price minus your cost basis. Your cost basis (because you filed 83(b)) is the value at grant (the same amount you already paid ordinary income tax on). So the gain = sale price minus value at grant. That gain is capital gain (short-term or long-term depending on how long you held). So:
  • Now (year of grant): Ordinary income tax on value at grant and attach copy of 83(b) to that year's return.
  • When it vests: No extra ordinary income.
  • When you sell: Capital gains tax on sale price minus value at grant.

Summary

• 83(b) = You chose to be taxed at grant on the value at grant.
• This year's return: Report that value as income, attach a copy of the 83(b), and pay the tax (or adjust withholding/estimated tax) for the year of grant.
• Vesting: No additional ordinary income.
• When you sell: Capital gains tax on the appreciation from grant to sale.
• Margen can help you model the tax at grant and the gain when you sell so you're ready for both.
• Consult a tax professional (or your startup's benefits/tax contact) to confirm the FMV at grant and how to report it on your return.

Related: Form 83(b) Restricted Stock Election · Should I File an 83(b)? CEO Startup Stake · Forgot to File 83(b) Election Within 30 Days · ISO Exercise, Reducing Tax via Trust

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Applicable Sections

Federal / IRS

• IRC § 83(b): Election to include FMV at transfer in income in the year of transfer. Once made, you are taxed at grant; vesting does not trigger additional ordinary income. When you sell, basis = FMV at grant; gain = sale price minus basis = capital gain. (IRS Form 83(b))
• IRC § 83(a): Default (if no 83(b)): income when property vests = FMV at vesting.
• Form 1040: Report the 83(b) income (FMV at grant) on your return for the year of the election; attach a copy of the 83(b) to that return. (See Form 83(b) instructions and Form 1040 instructions.)
• Publication 525: Taxable and Nontaxable Income; discusses restricted property and Section 83(b). (IRS Publication 525)

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Practical Notes

• 83(b) = Tax now (year of grant) on value at grant; no ordinary income at vest; capital gains when you sell (on appreciation from grant to sale).
• This year: Include the FMV at grant as income on your 1040 for the year you got the stock; attach a copy of the 83(b) to that return.
• You do pay tax now (for the year of grant), not only "after vest and cash out."
• Keep a copy of the 83(b) and the FMV at grant for basis when you sell.
• Margen can help you model tax at grant and gain on sale.
• Consult a tax professional (or employer) for exact reporting and FMV.

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Limitations

This answer does not cover state tax or withholding on 83(b) income. It is not tax or legal advice. For how to report the 83(b) on your return and for FMV at grant, consult a tax professional. Margen can help you model the tax at grant and at sale.