Section 83(b) and § 1.83-2(a) permit the service provider to elect to include in gross income the excess (if any) of the fair market value of the property at the time of transfer over the amount (if any) paid for the property, as compensation for services.      -IRS.gov

An 83(b) election can be a very beneficial and useful tool in tax planning.  This election allows a service provider (including W-2 employees or independent contractors) to include the value of property (other than cash and some stock options) received in return for services, less the amount paid for the property, in taxable income at the time the property is granted/awarded, even if there are still restrictions or forfeiture considerations on the receipt of the property.  Simply put, it accelerates your ordinary income tax.  It is important to note that Section 83(b) elections are applicable only for stock that is subject to vesting.

So, if property is transferred to an employee in connection with the performance of services, the person performing such services may elect to include in gross income the excess (if any) of the fair market value of the property at the time of transfer over the amount (if any) paid for the property.  If this election is made, any subsequent appreciation in the value of the property will be treated as capital gains income and not marginal income, assuming it has been more than one year from the date of the grant (your holding period clock also gets accelerated).  This election is made by filing a copy of a written statement with the IRS office which the person who performed the services files his/her return no later than 30 days after the initial property transfer.  The taxpayer is also required to file a copy of the same statement with his or her tax return for the taxable year in which such property was transferred.

There are a couple of significant disadvantages to keep in mind when considering making an 83(b) election.  When making an 83(b) election, you are betting that the stock will significantly appreciate in value.  Should the stock fall in value or should you leave the company before the stock vests, you will have paid tax on income that you never actually receive.  Also, keep in mind that you cannot write this loss off as a capital loss on Schedule D of your tax return.  Secondly, it is very difficult to revoke the election.  An 83(b) election can only be revoked with the consent of the IRS commissioner.  The regulations provide that such consent will only be granted where the person filing the election is under a mistake of fact as to the underlying transaction and must be requested within 60 days of the date on which the mistake of fact first became known to the taxpayer.

In order to highlight the advantages of filing an 83(b) election, we have developed two examples below.  For both, assume you receive 10,000 shares of stock subject to vesting, worth $5.00 per share at the time of grant, $15 per share at the time of vesting and $25 per share when sold more than one year later.  We will also assume that you are subject to the highest marginal tax bracket (39.6%) and the maximum long term capital gains rate (20%).

Example 1 – 83(b) election:  You receive a restricted stock grant and file a timely Section 83(b) election (within 30 days of the grant).  When you file your tax return for the calendar year, you will owe $19,800 as a result of making the 83(b) election.  Because you filed the election, you do not pay any tax when the stock vests, only on the later sale.  If you then sell the stock more than one year after the grant date, you will recognize a gain of $20.00 per share but paid at the applicable capital gains rate, not your marginal income tax rate.  This tax liability amounts to $40,000 ($20 x 10,000 x .20).  Your total gain is $190,200 ($250,000 – $40,000 – $19,800).

Example 2 – no 83(b) election:  Per the example title, you do not file an 83 (b) election in this case.  Hence, there is no tax due upon award as the shares are not yet vested.  When the shares do vest, you will incur a tax liability of $59,400 ($15 x 10,000 x .396).  Assuming you do not sell any of the vested shares to help pay for your tax bill at vesting and sell the shares after having held them for more than one year from the date of vesting, you incur another tax liability of $25,000 or ($10 x 10,000 x .20).  Your total gain in this example is $165,600 ($250,000 – $59,400 – $25,000).