Founders and employees of startups should be familiar with the 83(b) election. While the tax term sounds foreign and confusing, it’s quite simple. When startup founders or employees are issued restricted stock (subject to vesting), the stock is taxed at time of grant (when the stock is initially received) or when the stock vests. If the election is filed with the Internal Revenue Service (IRS), this accelerates the ordinary income tax, and the stock is taxed immediately. If not, taxes are deferred and taxed upon vesting. See more information regarding the topic below.
Overview of the 83(b) Election
- The stock is taxed now rather than later.
- Only applicable to stock subject to vesting.
- This “locks in” the price per share subject to taxation.
- Applies to both founders and employees of startups.
Timing
- The 83(b) election must be filed with the IRS within 30 days after the grant or purchase date.
Example
- A startup founder receives 100,000 shares of a stock initially valued at 0.0001 per share. The stock vests at 5 years. After 5 years, each share is worth 0.01.
- With election – the individual would be taxed immediately at the initial rate (100,000 * 0.0001) = $10 of ordinary income.
- Without election – the founder is taxed in 5 years at the current share price ($100,000 * 0.01) = $1,000 of income.
Advantages
- Assuming the company’s share price increases in value over time, the election reduces your overall tax liability.
- This starts the clock for long-term capital gain treatment. If the stock is held greater than one year, it’s taxed at a lower capital gain rate when sold.
Disadvantages
- The tax is paid immediately.
- If the company fails prior to vesting, the tax was unnecessarily paid.
- It is difficult to revoke a previously filed 83(b) election.
How to File
- Complete the following IRS form (see page 9 for template) and mail to the appropriate IRS Center address (see page 3).
