Understanding 83(b) Elections: A Crucial Step for Startup Founders and Employees
December 16, 2024 | By Kevin Vela
If you’re a startup founder or advisor, equity in the startup is a critical part of your compensation and financial upside. You’ve probably heard that you have to file an 83(b) election with your initial equity grant; failing to do so can have material consequences. This simple IRS filing can save you thousands (or even millions), in taxes down the road. Let me explain.
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; which almost all founders are – as the stock is typically restricted in terms of vesting. What you want to do is recognize the full value of the stock on day one, even if you may lose it down the road. Founders stock is typically worth some nominal amount on day 1, so the economic cost to this is minimal. 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 $.0001 per share (typical par value for day 1), or 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 (imagine you’re getting restricted stock for a more mature startup) 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. 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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