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After purchasing restricted stock in a company, so that the amount paid for the stock is exactly equal to its fair market value at the time of purchase, can you file an 83b election at that time? If so, does this mean you pay no taxes at the time of purchase?

In the explanations I have found, 83b is explained as a means to identify restricted shares as income at the time of purchase to help protect against the need to pay taxes on the difference in future value of the stock and the value at the time of grant.

In the extreme case, being given restricted stock at no price, one would need to pay taxes on the full fair market value if filing the 83b immediately. Or else pay taxes on the realized fair market value at the time the stock is vested.

But in the other extreme case, when you pay the full fair market price for the shares up front, does this mean that with an 83b election there is no tax liability at all (since there is zero difference between the amount paid and the fair market value at time of grant)?

If so, what happens in this case if the value of the shares rises before the vesting period ends? Normally the 83b protects the investor from needed to pay taxes at that point (unless she elects to sell the shares). Is that the same if the shares were originally purchased at fair market value rather than below market value?

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  • This suggests that if you purchase shares at their fair market value, then you can declare the 83b at that time with no tax liability. – ely May 2 '14 at 1:08
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83(b) election requires you to pay the current taxes on the discount value. If the discount value is 0 - the taxes are also 0.

Question arises - why would someone pay FMV for restricted stocks? That doesn't make sense. I would argue, as a devil's advocate, that the FMV is not really fair market value, since the restriction must have reduced the price you were willing to pay for the stocks. Otherwise why would you buy the stocks at full price - with strings attached that could easily cost you the whole amount you paid?

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  • In cases when paying the full FMV for restricted shares, the restrictions are almost always due to vesting requirements (as in, a company won't allow newcomers to have unrestricted stock unless they are paying in at a level higher than common shares). To account for this, there is almost always a refund arrangement for the purchase amount if something happens before the vesting period completes. While this doesn't ameliorate all risk associated with a purchase like this, if one believes the company is at least solvent for the short term, it makes it much more likely that you can't lose it. – ely May 2 '14 at 13:39
  • ... at least not until after it vests and it becomes a matter of stock value appreciation/depreciation (depreciation to the point of insolvency, perhaps). – ely May 2 '14 at 13:40
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    It is very common for early employees of startup companies to be granted stock options that can be exercised before vesting. The company has the right to buy back exercised but unvested stock when the person leaves. It is very common for the employee to exercise the unvested options immediately upon grant, and file 83(b) election, in order to start the clock on long-term capital gains, and pay no taxes on exercise, and since the stock is usually super cheap at this point anyway, there is little risk. – user102008 May 2 '14 at 23:41
  • @user102008 thanks for the explanation, I wasn't aware of such an option. – littleadv May 3 '14 at 18:46
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Yes, you would pay no taxes at the time of purchase. In fact, this is not uncommon. Many early employees of startup companies are offered stock options that can be "early-exercised" (exercised before they vest). In such a case, an employee who exercises immediately upon grant (and assuming the exercise price of the option is the FMV at the time of grant) purchases the stock at FMV, and there no no tax paid when filing 83(b) election.

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The tax cost at election should be zero. The appreciation is all capital gain beyond your basis, which will be the value at election.

IRC §83 applies to property received as compensation for services, where the property is still subject to a substantial risk of forfeiture. It will catch unvested equity given to employees.

§83(a) stops taxation until the substantial risk of forfeiture abates (i.e. no tax until stock vests) since the item is revocable and not yet truly income. §83(b) allows the taxpayer to make a quick election (up to 30 days after transfer - firm deadline!) to waive the substantial risk of forfeiture (e.g. treat shares as vested today).

The normal operation of §83 takes over after election and the taxable income is generally the value of the vested property minus the price paid for it. If you paid fair market value today, then the difference is zero and your income from the shares is zero.

The shares are now yours for tax purposes, though not for legal purposes. That means they are most likely a capital asset in your hands, like other stocks you own or trade. The shares will not be treated as compensation income on vesting, and vesting is not a tax matter for elected shares.

If you sell them, you get capital gain (with tax dependent on your holding period) over a basis equal to FMV at the election. The appreciation past election-FMV will be capital gain, rather than ordinary income. This is why the §83(b) election is so valuable. It does not matter at this point whether you bought the restricted shares at FMV or at discount (or received them free) - that only affects the taxes upon §83(b) election.

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