What is an 83(b) election, and why does it matter?
Marc Hoag via Midjourney
This is educational material and does not constitute legal advice nor is any attorney/client relationship created with this article, hence you should contact and engage an attorney if you have any legal questions.
What is the 83(b) Election?
Defining the 83(b) Election: The 83(b) election is a tax provision that allows individuals to elect to be taxed on the fair market value of restricted stock at the time of grant, rather than as it vests. This can result in substantial tax savings if the stock appreciates over time.
Who Can Benefit? Founders, early employees, and investors in startup companies are the primary beneficiaries of the 83(b) election. By making the election, they position themselves for potential tax savings down the line.
Why Make an 83(b) Election?
Tax Advantages: Making an 83(b) election allows you to lock in a lower tax rate if you anticipate that the value of the stock will rise significantly. You'll pay taxes upfront based on the current, lower value rather than the increased value at the time of vesting.
Aligning Interests with the Company: The 83(b) election aligns the financial interests of the individual with the long-term success of the company. By paying taxes upfront, the individual is essentially betting on the company's future growth.
Risks and Drawbacks
No Refunds: The IRS does not offer refunds on taxes paid upfront through an 83(b) election, even if the stock becomes worthless.
Complexity and Paperwork: Understanding the nuances of the 83(b) election and ensuring compliance requires meticulous attention to detail. Filing incorrectly or missing the 30-day deadline can result in a lost opportunity for tax savings.
How to Make an 83(b) Election: The Ultimate Checklist
Consult a Tax Advisor: Given the complexity, it's advisable to consult a tax advisor familiar with startup equity.
File Within 30 Days: The election must be filed with the IRS within 30 days of the stock grant.
Notify the Company: Provide a copy of the 83(b) election form to the company for its records.
Attach to Tax Return: Include a copy of the 83(b) election with your federal income tax return for the year.
Example Use Cases: 83(b) in Action
Startup Founders: For startup founders who acquire shares at a nominal cost, the 83(b) election is almost a no-brainer. The tax paid upfront is minimal, and the potential upside is significant.
Early Employees: For early employees offered stock options, the 83(b) election can be a double-edged sword. It makes sense if the company's prospects are strong, but it's risky if the company's future is uncertain.
The 83(b) election represents a calculated financial maneuver, and should generally be considered the default choice when founders’ stock is subject to vesting.