When to Pay Taxes on Restricted Stock Awards
The IRS typically treats restricted stock awards (RSAs) granted to employees as taxable income, based on the shares' value when they vest. But recipients of relatively low-priced shares—such as startup founders or early employees—may want to consider making a Section 83(b) election at the time of issuance to help avoid potentially higher taxes in the future.
What is an 83(b) election?
An 83(b) election allows you to pay income tax upfront based on the value of the shares on their grant dates rather than on their vest dates. (Gains at the time of sale would be taxed at a more favorable long-term capital gains rate of 0%, 15%, or 20%, depending on your income—plus a 3.8% surtax for higher earners.)
If you believe the share price will rise considerably between the time of grant and when the stock vests, an 83(b) election could reduce your overall tax liability. However, if the share price declines during that period, this strategy could work against you.
How does an 83(b)election work?
Let's say you receive an RSA of 100,000 shares worth $0.50 each on the grant date, for a total value of $50,000. Assuming you're in the highest federal income tax bracket of 37%, an 83(b) election would trigger an $18,500 tax bill ($50,000 × 0.37).
If the shares are worth $5 when they vest one year later and you decide to sell them, your gains would be taxed at a rate of 23.8%—as long as you've held the shares at least a year and a day. You'd owe $107,100 ($450,000 × 0.238) in capital gains tax on your earnings in addition to the $18,500 you paid with the 83(b) election, for a total tax bill of $125,600.
Had you not performed the 83(b) election, you'd owe federal income taxes on the full value at the time of vesting, generating $185,000 in taxes ($500,000 × 0.37)—or $59,400 more than with the election.
Should I make an 83(b) election?
To decide whether an 83(b) election makes sense for your situation, ask yourself:
- Where is the stock headed? If you feel the stock is undervalued relative to where it could be when the shares vest—before an expected IPO, for example—an 83(b) election could be a smart move. But if the price is relatively strong already, it may not be worth the tax consequences.
- Where are you headed? If you make an 83(b) election but then leave your company before all the shares vest, you will have paid taxes on stock you'll never own.
How do I file an 83(b) election?
If you choose to exercise your RSAs when you receive them, be aware you have just 30 days from the stock grant date to file an 83(b) election. You may write a detailed letter to request an election—until the IRS decides otherwise—but consider filing the recently released tax Form 15620 to ensure you include all necessary information to avoid any missteps. That said, currently the IRS will accept submissions by mail only, so keep a copy of the election for your records and also send a duplicate to your employer. A qualified tax advisor can help you think through the tax benefits and drawbacks of an 83(b) election, as well as ensure your request to the IRS is filed correctly.
What about RSUs?
Unlike RSAs, restricted stock units (RSUs) aren't eligible for an 83(b) election. That's because while RSAs constitute actual shares, RSUs are merely the promise of shares until they are vested and delivered, at which point the value of the stock is taxed at ordinary income tax rates. If you're unsure which type of restricted shares you've been granted, consult your company or a tax professional.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
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Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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