Maximize Your Equity Compensation: The Power of the 83(b) Election
Equity compensation can be an incredible tool for building wealth, especially for startup founders and employees in fast-growing companies. But with this opportunity comes a complex tax landscape that can significantly impact your financial outcomes. One powerful strategy to manage taxes effectively is the Section 83(b) election.
Filing an 83(b) election at the right time can save you thousands, if not more, in taxes. It allows you to pay taxes on the value of your stock when it's granted, not when it vests—helping you lock in lower tax rates while the stock’s value is still low.
In this guide, we’ll explore how the 83(b) election works, who should consider it, and how to decide if it’s right for you. We’ll also compare two scenarios—using the 83(b) election versus not using it—so you can clearly see the potential savings.
What is the 83(b) Election?
The 83(b) election is a choice you can make when you receive restricted stock or stock options as part of your compensation package. Without the election, you would pay taxes on the stock’s value when it vests—usually when the stock’s value is much higher.
The 83(b) election allows you to pay taxes upfront on the stock’s current value, at the time of the grant. If the stock grows in value, you pay less in taxes overall because the appreciation is taxed as long-term capital gains rather than higher ordinary income rates.
In short, the 83(b) election lets you lock in lower tax rates by paying taxes now instead of later when the stock’s value could be significantly higher.
Who Should Consider Filing an 83(b) Election?
Filing an 83(b) election can make a lot of sense for:
Startup founders who are granted stock when the company is just starting and stock values are low.
Employees receiving restricted stock units (RSUs), restricted stock grants (RSGs), or stock options as part of their compensation.
People exercising incentive stock options (ISOs) or non-qualified stock options (NSOs) early, allowing them to benefit from potential long-term capital gains.
However, the 83(b) election isn’t for everyone. If the stock doesn’t grow in value, or worse, if the company fails, you’ll have paid taxes on a higher value than the stock is eventually worth. This is why careful consideration and professional guidance are essential.
Filing the 83(b) Election: Timing is Everything
The IRS gives you 30 days from the date you receive your stock to file an 83(b) election. Miss this deadline, and you lose the opportunity to make the election.
Once you decide to file, here are the steps:
Fill out IRS Form 83(b): This form must include details such as the number of shares, the date of grant, and the value of the stock.
Send it to the IRS: You’ll need to send the form to the IRS within 30 days of receiving the stock.
Send a copy to your employer: They need to have a record that you’ve made the election for tax reporting purposes.
Keep a copy for yourself: Always keep a copy of your 83(b) election form in case you need to refer to it later.
If you miss the deadline, there is no extension and no way to retroactively file an 83(b) election. In this case, you will be taxed on the stock’s value at vesting, which can result in a much larger tax bill if the stock appreciates.
Why the 83(b) Election Can Save You Money: A Real-World Example
Let’s look at a simple example to illustrate the potential savings from filing an 83(b) election. Imagine you’re granted 10,000 shares of stock at a value of $1 per share. Three years later, when the stock vests, it’s worth $10 per share. Here’s how the numbers break down in two different scenarios: one where you file the 83(b) election, and one where you don’t.
Scenario 1: Filing the 83(b) Election
At the time of the stock grant:
You decide to file the 83(b) election and pay taxes on the stock’s value at the time of the grant.
Total taxable income = 10,000 shares × $1 per share = $10,000.
You pay ordinary income tax on this amount. Assuming a 37% tax rate, your tax bill is $10,000 × 37% = $3,700.
When the stock vests:
Since you’ve already paid taxes on the stock at the lower $1 per share value, you owe no additional taxes when the stock vests.
When you sell the stock:
After the stock vests, you sell it at $10 per share.
The difference between the sale price and the value you paid taxes on is considered a capital gain.
Capital gain = (10,000 shares × $10) - (10,000 shares × $1) = $90,000.
You pay capital gains tax on the $90,000 at the long-term capital gains rate of 20% ($90,000 × 20% = $18,000).
Total tax bill:
Tax paid upfront: $3,700.
Capital gains tax: $18,000.
Total taxes paid = $21,700.
Scenario 2: Not Filing the 83(b) Election
At the time of the stock grant:
You don’t file the 83(b) election, so you don’t pay any taxes upfront.
When the stock vests:
You are taxed on the stock’s value when it vests, which is now $10 per share.
Total taxable income = 10,000 shares × $10 per share = $100,000.
You pay ordinary income tax on this amount at a rate of 37% ($100,000 × 37% = $37,000).
When you sell the stock:
Since the stock’s value hasn’t increased after vesting, there’s no capital gain, and no additional tax is owed.
Total taxes paid = $37,000.
The Big Difference: $15,300 Saved
By filing the 83(b) election, you saved $15,300 in taxes. The reason? You locked in the lower tax rate on the stock when it was worth less. Without the election, you had to pay taxes on the higher value at vesting.
What if You Miss the 83(b) Deadline?
If you miss the 30-day deadline to file the 83(b) election, there’s no way to retroactively file. However, this doesn’t mean you’re out of options. There are still other tax strategies to explore that can help reduce your tax burden, such as:
Maximizing capital losses: If you have other investments that have lost value, you can use those losses to offset some of the taxes owed on your stock gains.
Strategic stock sales: If you don’t file the 83(b) election, you may want to consider selling your stock over time to spread out the tax liability.
In any case, missing the deadline should prompt a larger conversation with your financial advisor about the best way to manage your stock compensation moving forward.
The Bottom Line: Get Professional Guidance
Filing a Section 83(b) election can significantly reduce your tax liability, but it’s a decision that shouldn’t be taken lightly. While it can save you a lot of money if your stock appreciates, it also comes with risks. If the stock decreases in value or the company fails, you’ll have paid taxes upfront on an overvalued stock.
To make the best decision for your situation, it’s important to work with a financial planner who understands the complexities of equity compensation and taxes. At Wysopal Wealth, we specialize in helping equity-compensated individuals and startup founders navigate these decisions. We’ll help you determine whether the 83(b) election is right for you and create a plan that aligns with your long-term financial goals.
Key Takeaways:
83(b) election: Lets you pay taxes on stock when granted, locking in a lower rate.
Who should consider it: Founders, employees with restricted stock, and those exercising options early.
Missed deadline: No retroactive filing, but other tax strategies can help.
Consult a professional: Work with a financial advisor to make the right decision.
Think an 83(b) election may be right for you? Book an Intro call to find out.
