Filing an 83(b) Election for a Profits Interest

Receiving a profits interest as compensation comes with a time-sensitive decision on whether to make an 83(b) election. This choice, governed by Section 83(b) of the Internal Revenue Code, allows you to be taxed on the value of your interest when it is granted, rather than when it vests. For a profits interest, this can be a powerful tool because its value is typically zero on the grant date.

Understanding a Profits Interest

A profits interest is a form of equity compensation awarded by a partnership or an LLC taxed as a partnership. It grants the holder the right to a share of the future appreciation and profits of the company. This differs from a capital interest, which would give you a share of the company’s current value.

The defining feature of a profits interest is its liquidation value at the time of the grant. A properly structured profits interest has a fair market value of zero when issued. This is because if the company were to liquidate immediately after granting the interest, the holder would receive nothing, as their claim is only on the growth in the company’s value.

This concept is formalized in IRS guidance, specifically Revenue Procedure 93-27 and Revenue Procedure 2001-43. This guidance establishes that if certain conditions are met, the IRS will not treat the receipt of the interest as a taxable event. This zero-dollar valuation is the foundation for why an 83(b) election is so advantageous.

Because you are treated as a partner from the grant date, you will receive a Schedule K-1 and be responsible for taxes on your share of the partnership’s income annually. Filing an 83(b) election formally locks in the $0 grant-date valuation for tax purposes, ensuring that future appreciation is treated as a capital gain rather than ordinary income upon vesting.

Tax Implications of the Election

Making a timely 83(b) election means you choose to include the fair market value of the profits interest in your income in the year it is granted. Since a properly structured profits interest has a value of $0 at grant, this results in no immediate income tax liability. The primary benefit is that your capital gains holding period begins on the grant date. Consequently, any future increase in the value of your interest will be taxed as a capital gain when you eventually sell.

Consider a scenario where you receive a profits interest that vests in three years. If you file an 83(b) election, you report $0 of income. Three years later, the interest is worth $50,000. If you sell it more than one year after the grant date, the entire $50,000 gain is taxed at long-term capital gains rates.

Failing to make the election defers the taxable event until the interest vests. At each vesting date, the fair market value of the vesting portion is taxed as ordinary income. This could lead to a large tax bill, payable in cash, even though you have not sold the interest to generate any liquidity.

Using the same example, if you do not file an 83(b) election and the interest is worth $50,000 when it vests in three years, you would recognize $50,000 of ordinary income in that year. This income is subject to your marginal income tax rate. Furthermore, your capital gains holding period only begins on the vesting date, meaning you would need to hold the vested interest for another year to qualify for long-term capital gains treatment on any subsequent appreciation.

Information Required for the 83(b) Election

To file an 83(b) election, you must create a formal statement containing specific information required by Treasury Regulation 1.83-2. The IRS has also released Form 15620, which can be used to make the election. The statement must include:

• Your name, address, and Taxpayer Identification Number (TIN).
• A clear description of the property, such as the number and class of units received.
• The date on which the property was transferred (the grant date) and the taxable year for which the election is being made.
• A description of any restrictions on the property, such as the vesting schedule.
• The fair market value of the property at the time of transfer, which for a safe harbor profits interest is $0.
• A declaration that a copy of the election statement has been furnished to the company for which you perform services.

How to File the 83(b) Election

The signed election letter must be postmarked and mailed to the IRS no later than 30 calendar days after the grant date of the profits interest. This deadline is absolute and there are no extensions. It is highly recommended to use a mailing service that provides proof of timely filing, such as USPS Certified Mail with a return receipt requested.

You must mail the original, signed election statement to the specific IRS service center where you file your annual personal income tax return. The correct address depends on the state where you reside and can be found on the IRS website.

You are also required to provide a copy of the filed election to the partnership that issued the interest. You should also retain a copy of the election and the proof of mailing for your personal tax records.