How does 83b election work when paying fair market value at time of grant?

Question

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?

Answer 1

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?

Answer 2

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.

Answer 3

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.