What Happens If You Do Not File an 83(b) Election?
There is no requirement to file an 83(b) Election Form. By default, the IRS assumes that you have not filed it.
The IRS taxes Restricted Stock (stock that vests over time) using a “pay me now or pay me later” method. By not filing an 83(b) Election Form, you are telling the IRS that you want to pay them later.
The best way to explain this is to use an example:
In 2016, you cofound a startup and are immediately granted 1M shares of Restricted Stock that vests over four years. The fair market of the stock is $100 and you pay $100 for the stock.
During 2016, the startup does a financing and the valuation soars. Your 250K shares that vest at the end of 2016 are worth $1M. Because you did not file an 83(b) Election Form, you need to add $1M of taxable income to your 2016 tax return and pay about $400K in taxes. For the next three years, you will need to make the same calculation for the stock that vests during those years.
Assume the value of the startup does not increase over the next three years. Each year, the 250K shares that vest are worth $1M and this amount is added to your taxable income. So, you will have paid about $1.6M in taxes over the four-year vesting period.
The amount of taxable income that you recognized ($4M – $1M per year for four years) is added to your “basis” in the stock. So if you then sold the stock for $5M, your taxable gain would be only $1M and you will pay about $300K in taxes.
If an 83(b) Election Form was filed, you would have paid no taxes during the vesting period. If you then sold the stock for $5M, your taxable gain would be $5M and will pay about $1.5M in taxes.
As you can see, the IRS gets their taxes either way.