If your compensation includes restricted stock, there’s some financial magic you can perform to lower your future tax bill. It’s called an 83(b) election, but it’s only right in certain circumstances.
You only pay taxes once something is actually yours.
That’s why you don’t pay taxes on your equity compensation until it vests. When it’s granted, it’s not yours yet.
After it vests, you’ll be taxed on whatever the fair market value is on that day.
So if you had 100 shares vest today and the stock is worth $100/share, then you’ll have to report $10,000 of additional income on your tax return this year.
An 83(b) election allows you to pay taxes earlier than you have to. Yippee!
Why on earth would you want to pay taxes sooner than you have to? Because you might end up paying less overall.
It’s like Uncle Sam giving you the option to either pay him $50 now or $100 later.
When you choose an 83(b) election, you tell Uncle Sam that you’d rather pay taxes on the fair market value at the time of the GRANT instead of the time at the VEST.
So let’s say those 100 shares your company just granted you won’t vest until next year.
If the share price is $100 when they vest, you’ll owe Uncle Sam income taxes on $10,000 as already mentioned.
But today the share price is $50. So the fair market value today is just $5,000.
With an 83(b) election, you pay taxes on the $5,000 it’s worth now (at grant) instead of on the $10,000 it might be worth next year (at vesting).
($5,000 then becomes your cost basis and any gains over that will be taxed at a lower, long-term capital gains rate.)
The catch is that they are irreversible. Once you pay Uncle Sam, he ain’t giving you your money back even if your equity becomes worthless. OR worth LESS than you paid taxes on.
If the company folds or never IPO’s, your equity could be worthless. That means you paid taxes on income you’ll never actually receive.
Not quite as painful, is if the equity is worth LESS when it vests than when it was granted.
For instance, if the equity is worth $5,000 when it vests, but worth $10,000 when you did your 83(b) election, then you paid taxes on an extra $5,000 of income that you didn’t receive.
As always speak with your financial planner first. Only someone who knows your situation intimately can help you with this.
Some things to consider include:
They sound the same, but they are different. Restricted stock units (RSU’s) are NOT the same as restricted stock.
You typically get RSU’s with public companies.
You typically get restricted stock with pre-IPO companies.
And you can only do an 83(b) election on restricted stock, NOT on RSU’s.
An 83(b) election allows you to pay taxes on the fair market value of your restricted stock when it’s granted, instead of waiting until it vests.
This could save you a boatload of taxes if things turn out well for the company.
But if things don’t turn out well, you could pay Uncle Sam taxes on income you never receive.
83(b) elections are “in the weeds”, so make sure to consult a financial planner before making your decision.
And if you don’t have one, then talk to us. It’s literally our job to help people with this stuff!