How Restricted Stock is Taxed: The 83b Tax Election Could Save You Thousands
It can be a thrill when a job offer letter includes a grant of restricted company stock. Often it means the company considers you quite a catch and is trying to sweeten the deal any way they can. Many people are surprised to find however, that owning restricted stock can be a bit of a headache. This is especially true when it comes to taxation.
Depending on what kind of restricted stock award you have, there are a few different ways you can choose to have the IRS handle taxes.
Unfortunately, mistakes can cost you thousands.
What is an 83b Tax Election
If your restricted stock was granted to you in the form of an RSA or restricted stock award then you might be eligible for an 83b tax election.
Put simply, when you file for an 83b tax election you are choosing to pay income tax on your restricted stock at grant versus at vesting.
The 83b Tax Election in Action
Let’s say you just accepted your dream job offer. As part of the offer package you were granted 10,000 shares of company stock. You start the job and a few days later the 10,000 shares are granted to you. At the grant date the stock is worth $5 dollars a share or $50,000 altogether. After some research, you decide to file for an 83b tax election.
Since you decided to file for an 83b, you’ll pay ordinary income tax on the $50,000 value of the stock in the year that it was granted to you. So assuming you are in the top tax bracket, your total tax bill would be $18,500 dollars (50,000 x 37%).
Three years later, your stock vests and now it’s worth 10 dollars a share. Because you decided on the 83b you will not need to pay any taxes at vesting.
You observe that the stock has done amazingly well and decide to hold onto it for another three years, at which point you sell all 10,000 shares at 50 dollars a share. Since you held the stock for longer than a year, you will need to pay long term capital gains tax at this point.
The capital gains tax you need to pay is calculated by subtracting the $18,500 you already paid in taxes from the $500,000 you made from the sale and then applying the appropriate capital gains tax rate. Assuming you pay max capital gains, your tax at the sale will be $96,300 (500,000 – 18,500 x 20%).
So in this case, with the 83b election, the total taxes on your restricted stock award come to $114,800 (18,500 + 96,300).
What Would the Taxes be Without the 83b Tax Election?
Let’s use the same scenario, but look at how the taxes would work if you didn’t go an 83b tax election.
Again, say you are granted 10,000 shares worth 5 dollars a share or $50,000. Since you did not file an 83b tax election, you will not pay any taxes in the year that you were granted the stock. You will, however, pay taxes when the shares vest.
As the previous example, assume that your shares are worth 10 dollars each on the vesting date. At this point you will need to pay ordinary income tax on the value of your stock at vesting. In this case, you’ll pay $37,000 dollars (100,000 x 37%).
Like before, when you sell the stock a few years down the line you make $500,000. You subtract the $37,000 you already paid in taxes and then apply the capital gains tax rate to get a total capital gains tax of $92,600 (500,000 – 37,000 x 20%).
So without the 83b, the total taxes on your restricted stock come out to $129,600 (37,000 + 92,600). That’s $14,800 more than you would have paid if you’d filed for the 83b.
Why Doesn’t Everyone do an 83b Tax Election Then?
In the previous example, you saved a cool $28k by doing an 83b tax election. If it’s so profitable you might ask, then why doesn’t everyone do it?
The simple truth is that most people don’t know about 83b tax elections. And the ones that do know about them often don’t make the deadline.
What deadline you ask?
Well, the most annoying thing about 83b tax elections is that you have to file for them within 30 days of being granted your stock. That’s not a very long time! Most people in the throes of starting a new just don’t have time and find themselves missing the deadline.
Most of the time, an 83b tax election is beneficial. The most common pitfall is that if the original stock award is award is huge, your initial income tax in the year that the stock was granted will be a large amount and difficult to pay since you’ll have to do it out of pocket.
You can also get in trouble with an 83b if the price of the company stock actually drops from the grant date or the company goes out of business. In this case, you are paying income tax on money that you never had access to and that’s definitely a bummer.
Can I Use an 83b on my RSU?
Restricted stock units are different when it comes to taxes and fortunately a lot simpler.
RSUs are always taxed on vesting date. So when the shares vest you pay income tax and when you sell the shares you pay short term or long term capitals gains tax depending on how long you held the shares after vesting.
Nothing Certain Except Death and Taxes
As Ben Frankin said, “nothing can be said to certain, except death and taxes.
Any time you receive payment from your employer, whether that comes in the form of regular pay or restricted stock, you can bet your bottom dollar that the IRS will take a share.
If you have an RSU there’s not much you can do to lessen that burden. If you have an RSA, however, you have a choice. You can file your 83b within thirty days of your grant date, or you can wait and lose a potentially large amount of money.
If you haven’t been in touch with your financial planner or advisor and still have questions about how to handle your restricted stock, it could be a good time to contact that person. Or, if you don’t have a financial planner or advisor, you might consider finding one in your area who can help you work through your situation.
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