When you receive restricted stock awards, you need to decide whether you want to make a Section 83(b) tax election.
Without the Section 83(b) Election
With no Section 83(b) election, you must recognize taxable compensation income from your restricted stock award in the year the restriction causing the substantial risk of forfeiture lapses. For example, you would recognize income when vesting occurs.
The taxable amount equals the excess of the stock’s value when the restriction lapses over the amount you paid for the stock (if anything). Your employer must withhold federal income tax and applicable federal employment taxes on the amount treated as compensation.
With the Section 83(b) Election
You can make a Section 83(b) election to recognize income on the date you receive a restricted stock award.
Making the election results in the immediate recognition of ordinary compensation income equal to the excess of the stock’s value on that date over the amount you paid for the stock (if anything).
Federal income tax and federal employment taxes must be withheld and paid on the amount treated as compensation income. The Section 83(b) election must be made either before the share transfer or within 30 days after the share transfer.
The table below gives you the big picture of how making the Section 83(b) election compares with not making the election. In this table, the value of the stock appreciates from the (1) grant date to the (2) vesting date and again to the (3) sale date.
|No 83(b) Election||With 83(b) Election|
|Stock grant, year 0||25,000 shares||25,000 shares|
|Value $1 per share||$25,000||$25,000|
|Cash payment at grant date||$0||$20,000|
|W-2 compensation at grant date||$0||$5,000|
|Value at vesting, year 3||$40,000||$40,000|
|Cash payment at vesting, year 3||$25,000||$0|
|W-2 compensation at vesting, year 3||$15,000||$0|
|Selling price, year 5||$60,000||$60,000|
|Basis in stock, year 5||$40,000||$25,000|
|Long-term capital gain||$20,000||$35,000|
Note that with no Section 83(b) election, you pay $25,000 for the shares in year 3 (at vesting) and also pay taxes on $15,000 of ordinary income attributable to appreciation from the date of grant to vesting.
As you can see in the table, the big advantage to the Section 83(b) election when the stock appreciates is that your entire gain is long-term capital gain.
The Risks of Making a Section 83(b) Election
There are two risks:
- By making the election, you trigger a tax liability before you actually own the restricted shares, and you must come up with the cash to pay the tax liability.
- If you make the election and later have to forfeit the shares, you can claim a tax loss only for the amount you actually paid for the shares (if anything). You cannot claim a tax loss for the W-2 taxable income that you triggered by making the election.