Welcome to episode 21 of the Equity Compensation Guidebook and the fourth and final episode of our mini-series. Today we're going to tackle the topic of the good old 83B election. WARNING: we are going to talk about taxes. However, I promise I’ll do my best to keep it a step above boring. In this episode, I’m going to tell you what an 83b is and why someone would elect to go this route. I’m also going to share the advantages and the potential risks. Enjoy the show!
You will want to hear this episode if you are interested in...
What’s an 83b election? [1:00]
Why would someone go the 83b route? [3:14]
The risk to keep in mind when deciding [6:14]
Mitigating some of the risk [7:19]
This week’s FLASHBACK [9:02]
Just like any election, the choice is yours
83B elections apply to restricted stock awards and sometimes non-qualified stock options. When you are granted restricted stock, you get the stock...sort of. It goes into an escrow and sort of belongs to you. You get the dividends and have shareholder rights, but it’s not truly yours until you meet the vesting requirements. These are often time-related.
However, because the restricted stock is in escrow you have the option to do what is called an 83b election. It's called an election because the choice to do it is yours but the choice needs to be made quickly. You only have 30 days from the time your restricted stock hits escrow to fill out the necessary paperwork and file it with the IRS. That paperwork just says that you want to act like it’s already yours and pay the taxes now instead of later. Why would you want to do that? Check out the episode to find out!
Risk vs the reward that comes with the 83b
As there are with most investment strategies, there is the possibility of both loss and gain with this too. If you are earlier in your career or you know there will be a raise coming, taking advantage of the 83b can save you money in the long run. Right now it may not be enough to bump you up to the next tax bracket but it may be later. It may keep you out of an even higher tax bracket later. It could also mean the difference between paying capital gains in the future vs paying compensation rates when you’re in a higher bracket. On the flip side if you pay taxes on shares now and the value of those shares drops you will have paid unnecessary taxes because you don’t get a do-over.
This week’s FLASHBACK: Underestimating someone
I don’t recall how I ended up on a volleyball team that summer I worked at Cedar Point. The dorms were crappy and you can only stand to ride the rides so many times, so it probably had something to do with boredom. The league played under the lights on a beach on Lake Erie. We ended up with a decent team but it was primarily due to our secret weapon. Why?
Well, she was short and not the most athletic looking person. When the other team saw her, they thought nothing of her. To be honest, I thought the same thing at first sight. However, the first time I saw her serve, I knew we had a ringer. She had a devastating jump serve. It was a casual league and most people— like myself— barely knew how to play but our ringer had played for years. The goal of every match was to get her to serve because it was so hard to return one of her serves. She just dominated. It was fun match after match, seeing the chuckles when she was up to serve, but once she served, there was a look of defeat in the other team's eyes. She was a perfect example of why you should never underestimate anyone. I mean, unless you feel like getting a powerful jump serve delivered right to your face.
I’m Dan Johnson, CFP®, founder of Forward Thinking Wealth Management. I run a flat-fee financial planning and investment management firm located in beautiful Akron, OH. Although I am in Akron, OH, I work with clients regardless of location. I cater to owners of equity compensation positions who are looking to organize their financial lives, keep more of what they make, and do the things they want in retirement and even now.