Filing a 83(b) election tax form is beneficial for taxpayers that expect the value of certain stocks and securities to increase. If this step is taken and performed properly, employees and startup founders can pay taxes on the total fair market value of restricted stock at the time of granting. Electing to pay taxes when securities are granted, as opposed to when they vest, negates the need to pay taxes on “phantom income” each year. Phantom income can be triggered when the value of a company increases, not simply by exercising options or selling stock. Therefore, if, for example, you own stock in a startup that grows considerably, failing to file a 83(b) election could cost you major money. And if the securities are illiquid, you may owe taxes that are difficult to cover.
An 83(b) ensures that when the shares are ultimately sold, more of the gain is taxed at lower rates, increasing your after-tax proceeds. Usually, in the event that the securities appreciate, an 83(b) election results in lower taxes paid out overall. But compliance with 83(b) requires taxpayers to assess the fair market value at the time of the grant. This value drives what taxes are assessed.
The best place for taxpayers to begin is to seek an appraisal of the fair market value of their common and restricted stocks, options, and other investment securities. This will determine whether or not an 83(b) election is beneficial. If it is, the appraisal can support their 83(b) filing. It is important to note that an 83(b) election must be made within 30 days of the date the securities are granted. This prevents taxpayers from waiting until the appreciation has already occurred before electing the tax benefit.
If the stock value decreases, an 83(b) election cannot be reversed. Choosing such a tax strategy when the value of a company consistently declines means that taxpayers would have overpaid in taxes by choosing to prepay on a higher equity valuation. Another scenario where an 83(b) election would be a disadvantage is if the employee leaves the firm before the vesting period is over. In this case, they would have paid taxes on shares that were never received.
In essence, the cost of failing to file a 83(b) when stocks increase in value can be devastating. Likewise, choosing to file when stock values decrease can also prove detrimental. That is why an appraisal is so important. Independent valuations help taxpayers make the best, most informed decision possible, and ensure that the IRS has the supporting evidence necessary to honor 83(b) elections when applicable. Appraisals help taxpayers weigh the risks and rewards of 83(b), eliminating faulty assumptions and blind spots from the equation.