What is an 83(b) Election?
One of the most important things startup founders must understand what is an 83(b) election. Failing to make an 83(b) election at all, or filing it late, can have costly tax consequences for the individual founder. Section 83 of the Internal Revenue Code provides that a founder or employee recognizes taxable income on his or her stock as that stock vests. In other words, when your stock is subject to vesting over a period of time (which should be common for tech startups), you can be taxed on the difference between what you paid for the stock on Day 1, and what the stock is worth as it vests. This can lead to a significant tax liability for stockholders of fast-growing companies.
However, Section 83(b) allows the stockholder to make instead a voluntary election to recognize the taxable income upon purchase of the stock, as opposed to waiting until the stock vests. This allows you to accelerate that tax to Day 1, so that you pay tax on the difference between what you paid for the stock and what it is worth at that time – and in most cases there will be no difference, so you can essentially avoid tax on the stock as it vests.
83(b) Filing Considerations
There are a few essential considerations to bear in mind when you file your 83(b) election. First, and perhaps most importantly, you must file your 83(b) election with the IRS within 30 days after purchasing the stock. This 30-day period begins on the day you received the stock and includes weekends and holidays – so if you don’t make the election within this time frame, you will forever lose your chance to do so. If the stock is in a startup that increases dramatically in value in a short period of time, this can be a very expensive mistake. For example, let’s say you get 250,000 shares of stock, at a value of $0.0001, and fail to make your 83(b) election. If the stock vests after the first year, and the stock has increased to $1/share (maybe because the company did a Series A financing), the shares that just vested are now worth $250,000. Because you didn’t file an 83(b) election, you now owe tax on $250,000 minus the $25 that you paid for the stock originally, or $249,975.
We recommend that you file the election through certified mail, requesting a return receipt. This is important because the burden of proving that your election was filed promptly is placed on the person filing the election – you.
When you receive startup stock subject to vesting, it is always wise to consult your tax or financial adviser for assistance, particularly when considering an 83(b) election. Your startup lawyer will also be another resource to guide you through the process of launching your startup, including helping you understand the 83(b) election and the process of filing.