Let’s consider Jill, who becomes an employee of XYZ Company in June 2018 and is given a restricted stock award.
- Jill is awarded 1,000 shares of stock for $0 per share in June 2018 when the stock’s value is $25 per share.
- The 1,000 shares are subject to a 5-year vesting period with yearly cliffs.
- The price per share increases $5 each year.
- In 2023, after all 1,000 shares vest, the stock is valued at $50 per share.
- Jill continues to hold the shares until 2025, when she sells all 1,000 shares when the stock price is $60 per share.
The tax liability on RSAs is calculated using one of two methods:
You wait for the shares to vest, then immediately pay ordinary income tax on the vested shares by including the income in Jill’s Form W-2. Using the information from our example:
2019: 200 shares @ $30 = $6,000 included in Jill’s Form W-2
2020: 200 shares @ $35 = $7,000 included in Jill’s Form W-2
2021: 200 shares @ $40 = $8,000 included in Jill’s Form W-2
2022: 200 shares @ $45 = $9,000 included in Jill’s Form W-2
2023: 200 shares @ $50 = $10,000 included in Jill’s Form W-2
Total vested shares: 1,000
Total income included in Jill’s Form W-2 over 5 years: $40,000
Calculating Jill’s tax liability based on the vesting schedule yields the same amount of additional income included in her Form W-2 over a 5-year period – $40,000.
The second method Jill can use to calculate her tax liability is using an 83(b) election. Using this method, Jill pays ordinary income tax on all 1,000 shares immediately after receiving the stock award when she first joins the company, based on the share’s value at the date of grant:
2018: 1,000 shares @ $25 = $25,000 included in Jill’s Form W-2
Jill would earn $15,000 less ($40,000 – $25,000) using the 83(b) method to calculate her tax liability. If Jill’s tax rate was 20%, Jill would save $3,000 in taxes by using the 83(b) method.
Is an 83(b) election always a good idea? If you make an 83(b) election, you’re betting that your company is going to continue rising in value. You’re essentially pre-paying your tax liability on a low valuation.
But what happens if the opposite happens? You pre-pay your taxes at $25 a share, but then 5 years later the share price is $15? You could claim a capital loss based on the value of the shares, but the IRS won’t let you claim the overpaid taxes on your next tax return. You’re out of luck.
So understand that an 83(b) election is an option to pre-pay your tax liability. If you think the value of your company will increase over the next 5 years, an 83(b) election should be something to consider.
Sale Of RSA Stock:
If the stock is held for one year or longer past the exercise date, long-term capital gains tax rates apply. Otherwise any gain is considered ordinary income.