An 83(b) election is a provision of the Internal Revenue Code that allows the recipient of restricted stock to elect to include the value of the stock in their taxable income in the year of the grant rather than in the year the stock vests. This election is typically used in the context of startups and equity compensation. This would only apply to S corp stock that is subject to vesting. For this reason, an 83b election for S corps isn’t extremely common.

The benefit is that a founder or key employee would be taxed on the value of stock at time of grant (usually very minimal) compared to the value when the stock vests later on. If the value of the stock and company significantly increases over time, this could lead to a larger taxable event for individuals receiving the stock.  

Example Scenario

• An employee of an S corp is granted 1,000 shares of S corp stock on January 1, 2024, with a current fair market value of $1 per share.
• Without an 83(b) election, the employee would pay taxes as the stock vests (e.g., 250 shares per year over four years), potentially at a higher value.
• With an 83(b) election, the employee elects to include $1,000 (1,000 shares x $1) in their 2024 taxable income.
• If the stock’s value increases to $10 per share by the time all shares vest, the employee benefits by having paid taxes on the initial $1,000 rather than the higher value of $10,000 (1,000 shares x $10).  

83b Election for S Corps – Key Considerations

• Single Class of Stock – S corp shares have the ability to vest, however, S corps can only have a single class of stock. It’s crucial that the vested shares would not create a second class of stock.
• K-1 Reporting Complexities – For K-1 reporting purposes, unvested shares are generally not treated as having been transferred for K-1 reporting purposes (absent an 83b election). 
• Individual Filing – 83(b) elections are made by the individual receiving the vested stock, not the S corp. If you would like an S corp 83b election template, you can obtain on here – Click Here. 

Alternative Options to Incentivize Employees in an S Corp

• Employee Stock Ownership Plan (ESOP) – ESOPs are a great way to reward and incentivize key employees. An ESOP is a type of employee benefit plan that gives employees ownership interest in the company (as the ESOP becomes a shareholder of the S corp). ESOPs provide employees with stock ownership, often at no upfront cost to the employees. Shares are allocated to employees and may be held in an ESOP trust until the employee retires or leaves the company. ESOPs have vesting schedules that determine when employees gain full ownership of the shares. Vesting can be immediate or spread over several years. One benefit of ESOPs is that contributions or earnings on ESOP funds are tax deferred until withdrawal, usually at retirement. 
• Incentive Stock Options and Non-Qualified Stock Options – This is a bit trickier as S corps are able to issue stock options to employees, but once stock is exercised, the business would need to convert to a C corp.