IRS Releases New Form 15620 for Section 83(b) Elections
The Internal Revenue Service (“IRS”) has released IRS Form 15620, which can be used by taxpayers to make an Internal Revenue Code (“IRC”) Section 83(b) election (“83(b) Election”). With the release of Form 15620, taxpayers are no longer responsible for drafting an election form if they want to make an 83(b) Election, as was historically the case. Below is a brief overview of utilization of an 83(b) Election for taxpayers and how to make the election.
What is a Section 83(b) Election?
IRC Section 83(a) requires a taxpayer who is receiving property (e.g. shares of stock, membership interest, etc.) in connection with the performance of services to include the excess of the fair market value of the property over the amount paid (if any) for the property in his or her gross income at the time the property vests.
IRC Section 83(b) gives taxpayers the option to elect to include the value of certain unvested property in their gross income before the equity vests. The income will be equal to the fair market value of the property over the amount paid (if any) and included in the taxpayer’s gross income at the time the property is received. If this election is made, a taxpayer is permitted to pay income tax on the property at the taxpayer’s ordinary income tax rate on the date the property is received. If the property is eventually sold, any increase in the value of the property is taxed at the generally more favorable long term capital gain rate. The general idea behind making an 83(b) Election is that a taxpayer pays income tax on the fair market value of the property at the time of receipt instead of at the time of vesting, allowing for the property to increase in value over time.
It is important to note that 83(b) Elections are final, so if the property’s value decreases between the time it is received and the time it is sold, or if the taxpayer forfeits the property, this may result in an overpayment of taxes. Further, the 83(b) Election must be filed with the IRS within 30 days of the property grant.
Example of a Section 83(b) Election in Practice
An individual is the co-founder (“Founder A”) of a new company. As a part of Founder A’s compensation package, she receives 1,000,000 shares of restricted stock, with each share having a fair market value of $0.01. The total fair market value of Founder A’s shares at the time of grant is $10,000.
Five (5) years later, the company has been very successful and now Founder A’s shares are fully vested. The fair market value of each share is now $10.00. The total fair market value of Founder A’s shares at the time of vesting is $10,000,000.
With a Section 83(b) Election
Founder A will pay income tax on the fair market value of the shares at the date of issuance ($0.01 per share). Then, if Founder A ever decides to sell her shares, any income from the sale will be taxed at the generally more favorable long-term capital gain rate and not Founder A’s income tax rate.
Without a Section 83(b) Election
On the date of vesting, Founder A must include the total fair market value of the vested shares in her gross income. Founder A will be required to pay the less favorable ordinary income tax rate on the fair market value of the vested shares. This can lead to issues because the taxpayer may not have the cash proceeds to pay the tax associated with the vested shares.
How to make a Section 83(b) Election
To make a valid IRC Section 83(b) Election, the taxpayer must file a statement of election with the IRS within thirty (30) days of the transfer of the property that includes all required information under IRS Regulations Section 1.83-2(e).
Once the 83(b) Election has been completed and signed, the taxpayer must submit the document to the IRS via U.S. Mail. The document must be mailed to the same IRS office with which the taxpayer files their federal income tax return.
If you have any questions about an 83(b) Election or how you could be affected, please reach out to one of the attorneys in our business practice group for further information.