What are the consequences of the 83b election?
March 8, 2000
Subject: Section 83(b)
Date: 19 Feb, 2000
Hello and thanks in advance.
What are the tax consequences of electing Section 83(b)?
The consequence of making a Section 83(b) election depends on what you are dealing with.
For a non-qualified option where non-vested stock is received at exercise, the restriction is disregarded and income (and holding period for the stock) is measured on the date of exercise. The amount of income is the excess of the fair market value of the stock received (disregarding restrictions) over the exercise price.
For an incentive stock option where an early exercise is allowed, the fact the stock received is non-vested is disregarded and the tax preference is measured on the date of exercise.
When Securities Rule 16(b) applies (corporate insiders), the stock is considered to be restricted until the six-month period has elapsed.
If the election is not made, the preference isn’t measured until the restrictions lapse or the stock becomes vested.
The reason for making the election is to eliminate uncertainty about the amount of preference to be reported for ISO stock. The election is especially helpful when an option is exercised before an initial public offering.
The IRS has said in regulations issued during August, 2004 that for regular tax reporting, Section 83 doesn’t apply when an ISO is exercised, so the Section 83(b) election is not effective for regular tax purposes. The holding period starts on the date of exercise for avoiding regular tax ordinary income at disposition under the ISO rules.
If there is a disqualifying disposition of ISO stock, the ordinary income for unvested stock will be based on the excess of the fair market value over the option price on the earlier of the vesting date or the date of exercise.
If the employee is planning to make a disqualifying disposition of the stock, there is generally no advantage to making an early exercise of an ISO.