What is the 83(b) election?

As a founder or recipient of startup stock, you may be told to file an 83(b) election and have no idea why or what purpose it serves.

The short answer is relatively simple: if your stock is subject to vesting, an 83(b) election is a notice sent to the IRS – either using IRS Form 15620 or sending a standalone letter – requesting, pursuant to Section 83(b) of the Internal Revenue Code, to accelerate ordinary income tax recognition to the grant date rather than each of the future vesting dates. 

At first this may sound like legal/tax jargon, but the 83(b) election is generally beneficial and critical for three reasons.

Minimum Upfront Tax Liability

If your stock is subject to vesting, then it is most likely relatively inexpensive at grant date. You will pay a small amount and recognize no (or minimal) ordinary income tax in that year. For example, a founder who receives 9 million shares at par value of $0.00001 per share would only pay $90 (ie. 9,000,000 * $0.00001) for the shares. The founder recognizes $0 in ordinary income because they’re paying the full fair market value.

Favorable Long-Term Capital Gains

By recognizing ordinary income tax early, you start the clock on long-term capital gains treatment, which triggers after you’ve held the stock for at least 1 year. This can generate huge tax savings because the maximum long-term capital gains rate is 20%, which is generally much more favorable than ordinary income tax rates which can reach up to ~37% for the top brackets.

Reduced Administrative Burden

You avoid the administrative hassle of needing to determine the fair market value of your shares each time a tranche vests so that you can then determine how much ordinary income you have accrued. For example, if you have 9 million shares subject to 4-year monthly vesting, then each month you will have 1/48th (or 187,500 of the shares) vest and each month you’ll need to determine if the fair market value has changed. If, as an illustration, you hit a vesting date and the 187,500 shares are valued at $0.01 per share, then for this tranche you will recognize $1,856.25 in ordinary income (i.e. 187,500 * ($0.01 - $0.0001)). Constantly determining if/when a material event has occurred is challenging, leading to potential compliance issues and tax liability. And needing to get a new valuation each time may be an expensive and time consuming affair.

In any case, remember that an 83(b) election must be filed within 30 days of the grant date — a strict, non-negotiable deadline. You need to act fast.  Don’t hesitate to consult your tax professional!