Many entrepreneurs and employees may be familiar with the potential benefits of an election under section 83(b) of the Code / (an “83(b) election”) upon the receipt of “unvested” stock in the connection with the performance of services. Despite a knowledge of the basics of section 83, recipients of such stock may mistakenly believe, or be incorrectly informed, that an 83(b) election is not necessary if the transferred stock is forfeitable only if the recipient is terminated for “cause.” Below is a quick primer on section 83(a) and the potential benefit of an 83(b) election, followed by a discussion of circumstances under which a protective 83(b) election should be considered.

Benefits of Section 83(b) Election

In general, section 83(a) provides that if property is transferred to a person (the “service provider”) in connection with the performance of services, the service provider recognizes compensation (i.e., ordinary income) in an amount equal to the excess of the fair market value of the property received (e.g., employer stock) over the amount paid for such property, if any. If the property received by the service provider is subject to a substantial risk of forfeiture and is not transferrable (“restricted property”), the service provider does not recognize income with respect to the property until such property becomes substantially vested (i.e., when the property becomes transferable or the substantial risk of forfeiture lapses). Once the restricted property is substantially vested (the “vesting date”), the service provider recognizes income on the amount by which the fair market value of the property exceeds the amount paid for such property, if any, as of the vesting date. In the case of restricted stock and other equity, there may be significant appreciation between the date of the transfer (the “grant date”) and the vesting date, in which case, the service provider will be required to pay income tax on such appreciation at ordinary income tax rates.

An 83(b) election accelerates the recognition of compensation by the service provider with respect to restricted property from the vesting date to the grant date. In essence, an 83(b) election permits the service provider to avoid paying income tax at ordinary rates on the appreciated value of the restricted property between the grant date and the vesting date. An 83(b) election carries significant potential value, especially to the employee of a start-up company whose stock is likely to have a low value on the grant date and, assuming the start-up is successful, will greatly appreciate by the vesting date.

Stock Forfeitable for “Cause”

Stock is not subject to a substantial risk of forfeiture if the sole risk of forfeiture is upon termination for “cause” (as used in the Treasury Regulations) or for committing a crime. If the only risk of loss of stock by the service provider is based on “cause,” her expectation may be that the stock is substantially vested, and thus, an 83(b) election is not necessary. However, the definition of “cause” in an employment agreement (or equity agreement, etc.) may be broader in scope than the meaning of “cause” in the Treasury Regulations.

In Austin v. Comm’r, 141 T.C. 551 (2013), the employer granted company stock to an employee. The employee had to sell the stock back to the employer for less than fair market value if the employee was terminated for cause. “Cause” was defined to include the refusal to perform faithfully “the usual and customary duties of the employee’s employment.” The Tax Court held that the definition of “cause” in an employment agreement (or restricted stock agreement, etc.) does not necessarily have the same meaning as, and may have a broader meaning than, the meaning of “cause” as used in Treasury Regulations section 1.83-3(c)(1). In denying a motion for summary judgment, the Tax Court explained that the definition of “cause” that included the refusal to perform services may give rise to a substantial risk of forfeiture under section 83. The Tax Court’s decision left open the possibility that, in the absence of an 83(b) election, upon a lapse in the nontransferability or the risk of forfeiture of the stock, 100% of the income would be taxed as ordinary income, rather than capital gains.


In a situation similar to Austin v. Comm’r, an employee could incur substantial taxes at ordinary income rates which may have been avoided by making a protective 83(b) election within 30 days of the grant date. Assume Manager, an employee of a start-up software company, receives a grant of 100 shares of stock of the company on date X. The value of the stock on date X is $1/share. The equity agreement provides that the stock is nontransferable and subject to a risk of forfeiture only for cause. “Cause” is defined in the agreement to include any material breach by Manager of the equity agreement, including the failure by Manager to devote adequate on site time at the company’s principal offices. The risk of forfeiture lapses upon a change of control of the company. Years later, on date Y, the company is sold and the value of the company’s stock is $100/share. If an 83(b) election was timely and properly made, Manager would have incurred tax at ordinary income rates on $100 on date X and tax at preferential capital gains rates on $9,900 on date Y. However, if Manager failed to make an 83(b) election and the IRS or courts determined that the stock was subject to a substantial risk of forfeiture, then Manager would incur tax at ordinary income rates on $10,000 on date Y. Assuming an ordinary income tax rate of 40%, Manager could have saved $1,980 in taxes by making a protective 83(b) election while incurring little cost on the grant date (i.e., tax of $40 on $100 of ordinary income on the grant date).