In episode 60 of How Tax Works, Matt Foreman discusses equity grants, 83(b) elections, and common misconceptions with 83(b) elections. 

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How Tax Works, hosted by FRB Partner Matthew E. Foreman, Esq., LL.M., delves into the intricacies of taxation, breaking down complex concepts for a clearer understanding of how tax laws impact your financial decisions. Through this, listeners are treated to a comprehensive breakdown of entity structures, from the robust shield of C corporations to the flexibility of partnerships and LLCs. Foreman navigates through the maze of tax considerations, shedding light on entity-level taxation, shareholder responsibilities, and nuanced tax strategies. Foreman shares valuable insights and practical advice, emphasizing the need for informed decision-making and consultation with tax professionals. From qualified small business stock to state and local tax considerations, no stone is left unturned in this illuminating exploration of tax law and entity selection.

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Transcript:

**This transcript has been prepared automatically by AI and may contain inaccuracies**

Matt Foreman [00:00:11]:
Hello and welcome to the 60th episode of How Tax Works. I’m Matt Foreman. In this episode, I’ll discuss Section 83 elections— what they are, what they’re not, and common misconceptions. How Tax Works is meant for informational and entertainment purposes only. This may be attorney advertising, and it is not Please hire your own attorney. How Tax Works is intended to help listeners navigate the intricacies and complexities of tax law, regulations, case law, and guidance to demystify how taxes shape the financial and business decisions that we all make. Before we get started, a few administrative things. New episodes every 2 weeks.

Matt Foreman [00:00:46]:
Next episode will be the 7th time I talk about QSBS, Qualified Small Business Stock, and the 2nd time I talk about SAFEs, Simple Agreements for Future Equity. It’s a niche, niche topic, but I actually think it’s a really interesting way to look at both. And I get more questions about this than I would expect. So I think it’s worthy of an episode. I also want to point out I have some upcoming webinars. There will be a link on the main FRB page for How Tax Works for this episode. That’ll do it. November 3rd, passive activity loss limitations.

Matt Foreman [00:01:21]:
November 10th. And these are all an hour. They’re 1 o’clock Eastern. I believe they’re all Wednesdays. Let’s see. Note, November 3rd is a Tuesday. So they’re all Tuesdays. There we go.

Matt Foreman [00:01:30]:
So it shows what I know. Anyway, November 10th, selling a business, which is tax and non-tax considerations. November 17th, payroll taxes, which is Soarbound and Sirius. Really fascinating. Sirius, last week, I think it was, maybe it was 2 weeks ago, the 5th Circuit pulled back, which is really weird, their decision and issued a new decision with the same general determination, but totally rewrote themselves and actually kind of provided some analysis this time. So I thought that was interesting. Anyway, December 1st, Opportunity Zones 2.0, hopefully with regulations. December 8th, QSBS update, hopefully with regulations.

Matt Foreman [00:02:06]:
That’s going to be just pure QSBS. And December 15th, granting equity to employees and contractors, I guess. Anyway, so let’s talk about Section 83 elections. I talked about equity compensation in episode 6, talked about it a little bit in episode 7, but I dug into 83, 83. But I want to do a full episode on this in some level of detail. I obviously don’t go full detail because they’re only, you know, 20, 30 minutes. But because I get these like questions and they’re just sort of at the risk center, there’s sort of a fundamental misunderstanding of What is Section 83 and what does an 83 election do? I get these questions often, like at the end of the tax year or when people are like filing their tax returns and they ask these questions. I’m just like, I don’t know how to like answer them without being like, yeah, that’s, that’s not how this works.

Matt Foreman [00:03:05]:
It’s not— pardon me for a second. That’s not how tax works. Right. Right? That’s not what’s going on here. So I think it’s important. The first question is, what is Section 83 of the Internal Revenue Code and what does it do, right? ‘Cause you can’t get to 83 unless you start with 83, right? That’s how things work. You go first and second, or A then B, whatever, alpha, beta. 83 deals with the transfer of property in exchange for services.

Matt Foreman [00:03:32]:
It most commonly comes up With the transfer of equity. But if you get walnuts or alpaca fur in exchange for the provision of services, the receipt of the, the property is taxable. It doesn’t matter if it’s tangible personal property such as alpaca fur or intangible personal property such as equity Or an NFT or whatever, or real property such as a parcel of real estate. It is all taxed the exact same way. It can be a, it can be a thank you for prior services. It is not a gift. It cannot be a gift. This is Duberstein, unless there is, which is a very old case.

Matt Foreman [00:04:21]:
It involved the gifting of a Cadillac, which is viewed very differently today, I suspect. So unless there’s otherwise a relationship other than employee-employer or friend, right? It can be for current services that you’re providing right now or just provided, and it can be for the provision of future services. All right. The amount of income is determined under Section 61 and 83, and it is the fair market value of the property received less any amount paid. People always say, well, the services are only worth $37. But that property, that’s worth $400,000. Well, congratulations, they’re both worth $400,000. That’s how that works.

Matt Foreman [00:04:58]:
An arm’s-length transaction, they’re both going to be viewed as the same price. The amount is not yet income under certain circumstances, if such as it— and the common one is if it is subject to a substantial risk of forfeiture, which is defined in Section 83, or the property is not transferable. There are situations where there’s what’s called a non-lapse restriction. A non-lapse restriction is a restriction that by its terms will never lapse. Then you’re ignored. There are situations where non-lapse restrictions are just so far, you know, for 60 years, that’s non-lapse. You just ignore it. Non-lapse restrictions are further defined in 83, and there’s a lot of litigation I wouldn’t say a lot.

Matt Foreman [00:05:45]:
There’s some litigation, there’s some case law and things like that over what is and what is not a non-lapse restriction. So it’s important. There’s more stuff like that. If you’re not sure what one is, then you’re good. So what is a substantial risk of forfeiture? That is a very important question. And I will get to 83 after the music break. First, we’re going to talk about what is, what is, what is substantial risk of forfeiture? Sometimes you’ll see it SROF. I’m just going to say substantial risk of forfeiture every time because the word forfeiture itself is a tongue twister and I like to make it hard on myself, apparently.

Matt Foreman [00:06:20]:
So a substantial risk of forfeiture exists if the recipient’s right to full enjoyment, unfettered access, et cetera, is contingent upon the future performance of substantial services by an individual. So the question is, when is it— when is property transferable? And it’s transferable if rights to the property are not subject to substantial risk of forfeiture. Which is a gigantic circle. The way that I always talk about and evaluate a substantial risk of forfeiture is by examples. Examples are so much, so much, so much more helpful than actually trying to do it, because you’re like, well, what is substantial? What does that mean? Tax code takes great pains to never define terms like substantial. All right, so I’m going to give some examples of when there is a substantial risk of forfeiture and when there is not a substantial risk of forfeiture. If the risk is that if you get terminated, you get less money for the stock. So if you get terminated, you get $3 per share.

Matt Foreman [00:07:15]:
If you— I’m sorry. And then if you don’t get terminated and but you want us to buy it out or whatever, you’ll get the fair market value, you know, things like that. That is a substantial risk of forfeiture, believe it or not. If the risk of forfeiture is that you must work at the business for the year, but there’s no penalty for not doing so. Okay. Even if theoretically there’s one, but it’s not in the contract. Congratulations. That is not a substantial risk of forfeiture.

Matt Foreman [00:07:41]:
If the stock or if the property— I’m going to keep saying stock because the vast majority of the time when this comes up, it’s in the provision of equity. I could, you know, you could say LLC units, you could say stock, you could say partnership shares, things like that. That’s it. If you’re fired because you committed a crime, That is not a substantial risk of forfeiture. Okay. There is case law on this. There’s 2 tax court cases, Bernetta, 68 Tax Court 387, and Luden, I believe is how you say it. Luden, Luden, I’m not sure.

Matt Foreman [00:08:11]:
68 Tax Court 826. They’re both 1977 cases. So what was going on in the mid-’70s? I don’t know. But what’s really interesting is the IRS acquiesced in Budden and then Ludden came out and the Ninth Circuit affirmed it. So, you know, basically the IRS lost in both. But basically the position the IRS is saying is that, oh no, if you’re fired— is that the IRS said yes, if the clause says it’s forfeited due to being fired for committing a crime, that is a substantial risk of forfeiture. It’s really a timing question more than anything else. But the answer is no, that’s not.

Matt Foreman [00:08:50]:
It’s just not. Don’t commit a crime. Good legal advice there. I think the line by Jim Carrey in Liar Liar will always be good legal advice that any lawyer can give in any situation, which is quit breaking the law. That’s good advice. Okay. What about if there’s a non-competition or non-solicitation clause? So the answer is no, that is not a substantial risk of forfeiture. So if you leave, you can’t compete, can’t solicit.

Matt Foreman [00:09:16]:
That’s not a substantial risk of forfeiture. You must still, in this situation, you must still require substantial services. So if you leave subject to a non-compete or non-solicit, there is not a substantial risk of forfeiture. Citation for that is Richardson 64 Tax Court 621. That was a 1975 case. I’m of the opinion that a lot of non-competition, non-competes, non-solicit clauses are generally unenforceable, especially against middle managers and other similar type things. Senior people, people selling a business for a lot, things like that. That’s a different question.

Matt Foreman [00:09:50]:
But generally speaking, not a substantial risk of forfeiture because it’s just not, right? If you must sell the stock back to the business at the option price, the lower price, right? That is under the First Circuit a substantial risk of forfeiture because the value’s much less. Robinson, 805, Fed. 2nd, 38, First Circuit. The IRS has said they will not follow Robinson outside of the First Circuit, and IRS Treasury issued regulations that will support their position. So it’s really, really, really important to understand that that one might be a no outside of the First Circuit. I think First Circuit got it right, but the IRS will give you the opposite, and I suspect states will take the same position as the IRS. But it depends. We’ll see.

Matt Foreman [00:10:41]:
If you must forfeit the stock at the moment you leave, but you get paid at fair market value, that is not a substantial risk of forfeiture because you’re getting paid fair value. That’s it. That’s a substantial risk of forfeiture. Okay, we’re going to take a quick music break and we’re going to talk about what is an 83 election and when should you Okay, we’re back. How Tax Works. Let’s talk about 83 elections. What are they? When should, when should you consider make one? The first question is really the what, right? Which is not just a song by Biggie Smalls, right? The what is, if there is a substantial risk of forfeiture, then making an 83 election pretends for income tax purposes only that there is no substantial risk of forfeiture. And the equity or whatever the property is, is fully vested upon receipt.

Matt Foreman [00:12:01]:
That’s all it does. It does not modify the terms of the restrictions. It does not modify a purchase price. It does nothing else. It is a tax fiction, which is a term that tax practitioners use a fair amount. And the reason they talk about it a fair amount is because it is something that exists Solely for tax purposes, in this case income tax purposes. As I point out to people, 83 elections do not actually matter for sales tax purposes. So if there were sales tax or property tax or some other transfer tax imposed, congratulations, that’s not relevant, that’s different.

Matt Foreman [00:12:41]:
The when, okay, when should you make one? I’m never going to tell you Or anyone, whether they should make an 83 election. I’ll go through the positives and negatives, which I’m not doing here. I’ll talk about it at a high level, but not here. The when is actually the timing of the 83 election. Generally speaking, you want to make one if you think the value will go up. Okay? If you think the value is going to go down, first off, why are you taking it? Secondly, why would you make an 83 election and pay the tax now? I’ll talk about that a little later. But you have 30 days from the date of the grant. The grant is day zero.

Matt Foreman [00:13:17]:
So if the grant is on January 1st, you must make the election on or before January 31st. How to make the election, right? We have what, we have when, now we have how. You can make your own form. Historically, everyone had to make their own form, or more accurately, their tax advisor had to make a form. I always thought this was pretty strange. There’s like a revenue ruling, a revenue procedure. This is what has to be in it. If you re— if you get the forms that people made, they looked really, really similar.

Matt Foreman [00:13:50]:
Candidly, half of them are because, oh, I saw someone lab that, let me use this other one, let me reuse it, and that’s it. Which is not— no, no comments. I’ve done it myself. The IRS, I think it was in ’25, I don’t remember exactly when, created IRS Form 15620. Which is an election for 83. Awesome. Really exciting. Finally made it so you don’t have to make your own.

Matt Foreman [00:14:14]:
It’s machine fillable. Pretty easy to use. Earlier this year, the IRS created an online portal through what’s called ID.me. ID.me is what the IRS’s e-services, which is all of the IRS’s sort of online electronic way of communicating with people. Goes through ID.me. It’s pretty good, actually. It’s actually pretty, pretty well done. It’s something they’ve been working on for a while.

Matt Foreman [00:14:41]:
I don’t know, like 4 years, 5 years. They’ve really been implementing it over probably like 6, 7, something like that. But it’s a long planned thing. Anyway, created a portal where you can just type in the information and make the 83 election yourself, and it’ll send to you a PDF of the 83 election, which is really important. Because there’s 2 more steps, right? You can file it any way you want, your own form, the form, or online. Then you have to make a copy, include a copy with your tax return for that year. So if the grant was in 2025, you will file it with your 2025 tax return that you’re going to make to file in 2026. Also, you have to give a copy to the grantor of the property.

Matt Foreman [00:15:24]:
In the case of equity, that’s the company itself. Okay. Because they need to file a copy with their business’s tax return. Someone asked me, I should say someone asked me, I get this question a fair amount. Can a business require you to make an 83 election? Conceptually, I suspect they actually can’t force you to make one. However, I would be extremely surprised, extremely surprised if they couldn’t pretty legally say, look, you get this equity, but you’re getting this equity or this alpaca fur or whatever. Subject to the fact that you make an 83 election. I think that’s valid.

Matt Foreman [00:16:03]:
I do it a lot. I do it a lot because a lot of times the restriction on the equity includes vesting. And if you make an 83 election upon grant, then it’s as if all the vesting happens. Often that’s at a value of zero or very little, or you know the value. If you have monthly vesting, And you have to know the value of the property that you granted, that was granted every single month, every single month. That’s a headache from an accounting perspective. And this is important. When you receive equity under Section, or any property under 83, it’s ordinary income.

Matt Foreman [00:16:39]:
So it’s taxable. And because it’s considered compensation income, it’s subject to employment taxes. So this is your employer granting it. or you’re a partner, you’re either going to get a 1099 if you’re a contractor or a part owner of like an LLC partnership, or you’re going to get a W-2 for it, and that’s going to be included in it. So I think it’s really important from an administrative headache, from a compliance perspective, it’s so much easier if you just make everyone do an 83 election, or that’s it, they don’t get it. I think that’s really, really important. The business also, and this is really important, the business also gets a fairly, you know, a deduction in the same amount as taxable income. So for example, you know, public companies, the Apples, the Amazons, whatever the world’s— I’m not even going to get out of the letter A, you know, when they grant equity to employees, they’re getting a deduction for a non-cash expense.

Matt Foreman [00:17:33]:
So this is, you know, can be a really nice way for a business to lower its taxes by just granting equity. Obviously, there’s a point beyond which it’s going to hurt the overall value of the company. So, you know, you can’t, you know, flood the market totally, but it’s definitely a way to lower taxes a bit, which, you know, obviously can be good. Can be good. We’re going to get some music in here and then we’re going to talk about common mistakes, misconceptions, and generalized sort of places where people might not understand, you know, what an 83 election is. All right, we’re back. So let’s, let’s talk about common mistakes, misconceptions, and when you can’t make an 83 election. So I just have a list, really 2.

Matt Foreman [00:18:59]:
The first one is When the property is already vested, for reasons I don’t understand, is every so often I’ll get it and they’ll be like, hey, you know, I worked for this company or I did some work for this company and I got some stock, you know, 27 years ago or whatever. And they’re selling the company now or it’s IPOing. So I want to make an 83 election to lower my taxes. And I have to like politely explain to people That A, you can’t make an 83 election because it’s fully vested. And B, I’m not really sure it would’ve— I don’t know how that would lower your taxes, so I’m not totally sure how to approach it. So if the property’s already vested, then you can’t do it. The second one that I get a lot is you can’t make an 83 election on restricted stock units. You can make one on restricted stock awards.

Matt Foreman [00:19:49]:
I don’t know if you heard the horn honking. Welcome. Welcome to New York, where I love them. Restricted stock units are when the grantor, in this case, you know, the business, has the option at their election to compensate you either with equity upon the full vesting, or they can give you cash. That’s a restricted stock unit. Because you can get cash, there is no ability to make an 83 election. Conversely, if you’re getting a restricted stock award, which is the same thing, but the grantee, the recipient, can only get stock or units in LLC, members, you know, partnership units, whatever, equity of some sort, that you can make an 83 election. If there is the next one, if there is no ascertainable fair market value, the IRS is— I’ve said this before and I say this every so often— the IRS is of the opinion that There is no situation where there is no asset retainable fair market value.

Matt Foreman [00:20:49]:
There is if there’s litigation and there’s sort of really big issues, but the IRS is of the opinion that you can value everything. They’ll probably pick higher values a lot of times than we would, but here we are. Or the other one is a couple more transactions. Transactions under Section 421, which deals with incentive stock options or ISOs. 401, which are qualified plans, 401, 403, IRA— maybe not an IRA because that’s not employer— or anything where Section 409 Cap A is triggered, it is important to note that Section 83 itself overrides 409 Cap A because it makes it taxable immediately. So they’re not worried about it from a 409 perspective. Conversely, if a situation is, generally speaking, governed by 409 Cap A, then you can’t make an 83 election ’cause 83 itself was not triggered. There’s a couple more.

Matt Foreman [00:21:41]:
There’s a couple more that I think are pretty important. If you paid the fair market value, I have a guy who every year comes to me and says, I want to make an 83 election on this stock that I got. Great. I look at it and he paid $400 a share, which was the fair market value at the time. I don’t know how you can’t make an 83 election if you bought the stock 83 again deals with the transfer of property in exchange for services. The transfer of property in exchange for cash does not trigger Section 83. Therefore, you can’t make an 83 election. Another situation where you are a founder or there are founders where no one actually put in money.

Matt Foreman [00:22:22]:
If everyone puts in cash, the— or excuse me, services, the assumption, which I think is a correct assumption, We all know what happens when you assume. The assumption is very simple. It is that, no, the value of the equity received was zero. If the value of the equity received is zero and there is no vesting, then you can’t make it. The same where everyone puts in $200 or they pay par value or whatever. No, no 83 election necessary. I don’t really know what par value is. Some stock, in companies for reasons I don’t understand needs to have like, like almost like a stated value.

Matt Foreman [00:23:00]:
I don’t know why. It is not a tax issue. It is a corporate law issue and people use it. Oftentimes it is a fraction of a fraction of a fraction of a cent. I don’t really get what it is. I don’t deal with it because it doesn’t exist for tax purposes. So I don’t, I don’t know. I don’t know.

Matt Foreman [00:23:16]:
I’m sure I’ll get an email being like, how do you not know what par value is? And I’ll be like, that’s fine. You don’t know what 83 elections do. So maybe you do now. If you were granted equity without restrictions, founder shares, advisory shares, those too, if there’s no restrictions on them, they’re vested immediately. Congratulations. There’s no reason to make an 83 election. I get questions about making 83 elections on SAFEs. SAFEs are just putting in money.

Matt Foreman [00:23:41]:
You know, they’re kind of a prepaid forward contract. They’re kind of debt-ish, but they’re definitely not something where you need to make an 83 election. I don’t know how you’d make it on what, because you paid for the SAFE. Conversely, if you were granted a SAFE as compensation and the SAFE vests over a period of time and there is a substantial risk of forfeiture, then you may be able to make an 83 election on a SAFE, which would be the safe thing to do. You’re welcome. So that’s it. So when I say you can’t make an 83 election on SAFE, I mean it’s on one you bought. not on one that was granted to you, because safes are property in some form that was given to you in exchange for services.

Matt Foreman [00:24:22]:
So a couple more final misconceptions and common questions. Hey, can I make a late election for 83? Can you? No, you can’t. Well, can you petition the IRS? I can petition them. They’re going to say no. They are extremely unyielding. This is sort of like a quirk that you can make this election in general. So no, you can’t do it. There are no late elections for 83.

Matt Foreman [00:24:43]:
I’m sorry. Can you revoke election? No, probably not. I don’t really know how. I don’t understand how. So like, no. Can I get the taxes back if the value of the property drops to zero? No. Uh, what happens is you have a capital loss in the— that, that is in the amount of the fair market value of the equity or whatever the property is when it was granted to you and when the 83 election was made. Really, when the 83 election was made, which is going to be simultaneous with the grant.

Matt Foreman [00:25:11]:
So that’s what you get. It is likely, you know, maybe long-term capital gains, maybe short-term capital gains, depending upon the holding period. Section 83 election will start the holding period for capital gains purposes, also will for QSBS purposes and other similar things where you need a longer holding period. But it’s important to remind people that, you know, the gain when you make the 83 election because this is Section 83, is compensation for services, it’s ordinary and it’s subject to so-called payroll taxes, FICA, FUTA, Social Security, stuff like that. So if you’re really not sure what’s going to happen with what you’re being granted, maybe don’t pay ordinary income tax now, maybe delay it, see what goes on. It depends, right? What if— it’s a question I get, I would say once a year— hi, I forgot to file a copy of my 83 election with my tax return, or, hey, my employer forgot to file a copy of my 83 election with the tax return. You— I don’t know. I would take the position that you made it.

Matt Foreman [00:26:17]:
I’m not really sure. I’ve never really researched it, but I would take the position that you make— you made it because you did in fact alert the IRS. We’ll see what happens. You know, I don’t know. I don’t know. All the stuff for 83 elections is in sub-regulatory guidance anyway. It’s in revenue rulings. And revenue procedures is not regulations.

Matt Foreman [00:26:34]:
So we’ll see. For the business, I got to be honest, I think this one’s actually less of an issue if the business forgets, because really the taxpayer should do it. The question to me is more, did the business itself act as if you made it? Did it recognize the deduction? Did it include it in your W-2? Why did it forget? You know, did it forget? Did it necessarily forget? Did it not know? You know, I’ve had situations where people are like, hey, let us know if you make an 83 election. And the employee just doesn’t tell them, like, let us know if you make it. We will not ask again. Employee makes it and says, hey, you know, I made it. I didn’t see it in my W-2. I didn’t see my 1099.

Matt Foreman [00:27:17]:
Like, what do you mean you made it? You had to tell us. And they’re like, oh, well, okay. Do I need to amend my return? Technical answer is yes, you absolutely need to amend your return. Will anyone actually amend a return over a missed attachment for an A3B election? Probably not. I don’t, you know, I think the business not including it is probably less of an issue for the taxpayer, you know, than the person who actually made the election. All right. Well, that, that was the 60th episode of How Tax Works. 60.

Matt Foreman [00:27:48]:
I can’t believe we’re at 60, right? That’s kind of crazy. It’s kind of crazy. I hope you learned something. I’ll be back in 2 weeks, 61st episode, which will be about the confluence of QSBS and SAFEs, which is a question I actually get a lot from really early investors and wealth managers. It is for reasons that are— I mean, I actually really understand it why, but somewhat unclear why those 2 groups are the ones that really ask the question the most and not like companies or not like— I really don’t get it from accountants that much. Maybe it’s because they kind of know the answer, but I get it. And it’s, it’s an interesting question. So it’ll be hopefully an interesting podcast in 2 weeks.

Matt Foreman [00:28:25]:
But, uh, you know, today, today I would— this, this was gonna be released on the last day of August. So hope everyone had a good summer. The next one will come out after Labor Day, which as we all know is the end of summer unless you live in like Brazil, you know, or, or, uh, Australia or a lot of other countries that I’m just not naming. ‘Cause it’s the end of my day and, you know, here we are. And then I hope you have a good spring and then we’ll hit summer. But thanks for listening. And now, best song of all time.