Understanding 83(b) Elections: A Crucial Step for Startup Founders and Employees
December 16, 2024 | By Kevin Vela
If you’re a founder or an early employee at a startup, equity compensation is likely a significant part of your financial upside. However, the promise of equity can come with a maze of tax implications. Enter the 83(b) election: a relatively simple IRS filing that can save you thousands (or even millions) in taxes down the road. Despite its importance, many people overlook it—sometimes to their detriment.
What Is an 83(b) Election?
An 83(b) election is a proactive choice to pay taxes on the total current value of your equity at the time it’s granted, rather than when it vests. This is particularly relevant if you’re receiving restricted stock as part of your compensation.
Without an 83(b) election, the IRS will treat each vesting milestone as a taxable event. This means you’d owe taxes on the stock’s value as it increases over time—even if you haven’t sold any shares to cover the tax bill. By making an 83(b) election, you’re freezing the tax assessment to the moment the stock is granted, potentially at a very low value.
Why It Matters
Imagine this scenario: you’re granted 100,000 shares of restricted stock in a promising startup when the stock’s value is essentially zero. Over four years, as the company grows, your shares vest and increase in value to $5 each. Without an 83(b) election, you’d owe income tax on each batch of vested shares at their $5-per-share value—a hefty tax bill.
With an 83(b) election, you’d pay taxes upfront on the negligible initial value, locking in significant tax savings. When you eventually sell the shares, the profit will typically be taxed at the lower long-term capital gains rate instead of the higher ordinary income rate.
Timing Is Everything
Here’s the catch: an 83(b) election must be filed within 30 days of the stock grant. This deadline is non-negotiable. Miss it, and there’s no do-over.
To file an 83(b) election, follow these steps:
- Complete the IRS 83(b) election form.
- Mail the form to the IRS within 30 days of the stock grant. Be sure to send it via certified mail for proof of delivery.
- Provide a copy of the election to your employer.
- Keep an additional copy for your personal records and include it with your annual tax return.
When an 83(b) Election May Not Be Right for You
While the 83(b) election is a powerful tool, it’s not universally beneficial. If the stock’s current value is significant and there’s a high risk the company won’t succeed, you could end up prepaying taxes on equity that becomes worthless. This is why consulting with both your legal counsel and a tax advisor is essential before making the election.
Final Thoughts
The 83(b) election is a small but critical step for anyone navigating the complexities of equity compensation. By taking the time to understand it and file appropriately, you can avoid unwelcome tax surprises and position yourself for long-term financial success. Remember, equity is a powerful tool—but like any tool, it’s most effective when used wisely.
If you’re unsure about whether an 83(b) election is right for you, consult with your legal or tax advisor. As we always say at Vela Wood, making an upfront investment in legal advice can save you significant time, money, and headaches down the road.
About the Author(s)
Kevin Vela
Kevin is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, M&A, fund representation, and gaming law.
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