What is an 83(b) election and when do I need one?

If you’re a founder or employee receiving stock that vests over time, you need to know about the 83(b) election.

Why? Well, it can have a huge impact on your future tax liabilities, potentially saving you a lot of money.

In this article we’re breaking down what an 83(b) election is, when it makes sense to file one, and how to do it correctly.

What is an 83(b) election?

An 83(b) election is named after Section 83 of the Internal Revenue Code. It’s an election that lets you pay taxes on the fair market value (FMV) of your stock when it’s granted, instead of when it vests. This could make a huge difference if your stock vests over time (which is common for startup founders and employees).

Without an 83(b) election, each time a bit more of your stock vests, it’s considered taxable income – and that could mean you pay more tax on the vesting stock as its value grows over time.

What impact could filing an 83(b) election have?

Imagine an early-stage founder is granted 40,000 shares at a purchase price of $0.02 per share, ‘vesting over four years with a one-year cliff’. This means 25% of their shares (10,000 shares) vest after one year, with the rest vesting monthly over the next three years.

At grant, the shares’ fair market value is low – also just $0.02 per share, or $800 total. But they expect the stock’s value to rise significantly, reaching $5 per share by the end of the four-year period.

Here’s what the tax situation would look like with and without filing the 83(b) election (we’ll ignore any employment or state tax impacts).

Option 1: The founder does file an 83(b) election

If the founder files an 83(b) election, they’ll pay tax on the stock’s fair market value (FMV) at grant, before it vests. Since they are purchasing the shares at the same FMV of $0.02 per share, their total initial taxable income is just $800 (40,000 shares x $0.02).

Assuming a 37% income tax rate (the maximum ordinary income tax rate), this means a tax payment of $296.

Since they’ve already paid tax on the shares upfront, they won’t owe any additional income tax as the stock vests – which becomes especially beneficial if the stock’s value increases over time.

Altogether, their total income tax liability with the 83(b) election is $296.

Option 2: The founder doesn’t file an 83(b) election

If the founder doesn’t file an 83(b) election, they’ll pay income tax each time stock vests, based on the fair market value at the time of vesting.

This means after the first year, 25% of the stock (10,000 shares) vests. If the FMV has increased to $0.50 per share, this creates $5,000 of taxable income (10,000 shares x $0.50). At a 37% tax rate, this results in a tax bill of $1,850.

In the second year, as shares continue to vest monthly, let’s say the FMV reaches $1 per share. They now owe tax on an additional $10,000 (10,000 shares x $1), bringing the tax bill to $3,700 that year.

By the third year, the FMV could have risen to $3 per share, and this year’s 10,000 vested shares lead to $30,000 of taxable income – this creates a tax liability of $11,100 for year three.

By year four, the stock’s value has grown to $5 per share. This results in $50,000 of taxable income (10,000 shares x $5), with a tax bill of $18,500 that year.

Over these four years, the total ordinary income tax paid on vested shares reaches $35,150.

In total, without the 83(b) election, the founder’s tax liability is $35,150 compared to $296 if they had filed an election. The election meant their tax bill was based on the fair market value of their stock at grant – regardless of any future appreciation in its value.

So, even if the share value rose to $100 after the four years, as long as they’d correctly filed an 83(b) election, they still wouldn’t pay income tax when the stock vests.

83(b) elections can simplify your tax reporting

Filing an 83(b) election isn’t just about tax savings – it also reduces administrative burdens for both founders and companies.

Without it, each vesting event triggers a new taxable event for the founder, meaning the company must determine the FMV at each vesting date, handle tax withholding, and cover its share of employment taxes.

Filing an 83(b) election simplifies reporting and eases the administrative load for everyone involved.

When should I file an 83(b) election?

You need to file your 83(b) election within 30 days of receiving the shares.

This is a strict deadline, so if you miss it, your shares will be taxed as ordinary income when they vest.

When shouldn’t I file an 83(b) election?

Filing an 83(b) election is almost always a good idea when you have shares that are subject to vesting.

But there are some situations where it may not make sense.

High upfront tax cost

If your stock’s granted at a high fair market value, choosing an 83(b) election means you’ll have to pay a large tax amount on the total value upfront. For instance, if you’re granted 100,000 shares valued at $5 per share, this results in $500,000 of taxable income, which could lead to a federal tax bill of $185,000 (assuming the maximum ordinary income tax rate of 37%). Paying taxes on that amount could be tough if you don’t have the cash on hand, so it might be better to spread tax payments over time as and when the shares vest.

Concern about the stock’s future value

If you’re uncertain about the company’s growth prospects, it may be wise to hold off on an 83(b) election. Filing an election to pay tax upfront could mean you end up taxed on a value that never materializes. Without an 83(b) election, you’d only pay tax on the actual (possibly lower) value of the stock as it vests – which could reduce your tax bill. Although, by doing this, you’d be betting that the company would actually fall in value while you hold stock!

Uncertainty about staying through the vesting period

If you leave the company before your stock vests (or fail to meet other vesting requirements), you’ll probably forfeit any unvested stock.

If that happened, you would still be out-of-pocket for the tax you paid upfront. Since 83(b) taxes are non-refundable, this can mean you’ve paid tax for shares you never received.

Who is responsible for filing an 83(b) election?

Whether you’re an employee, founder or consultant, if you’re receiving the stock, then it’s your job to make the 83(b) filing with the Internal Revenue Service (IRS).

The company might give you some guidance on the process, but the responsibility to complete the paperwork rests with you.

We’ll go over how you file your 83(b) election below.

How do I file an 83(b) election?

1. Prepare the election document

If you create a Founder Agreement with SeedLegals, we’ll do this for you.

Otherwise, you can access the 83(b) election form on the IRS website here.

2. Sign and send the document

Once you’ve filled in the form (or we’ve sent it to you), here’s what you need to do:

• Date and sign the form – you can sign it either electronically or physically
• Make four copies of the forms once they’re completed.
• Mail one copy to the IRS Service Center where you file your tax return, ideally using certified mail with a return receipt. You can find the address for your IRS Service Center here.
• Attach a cover letter and self-addressed, stamped envelope for the IRS to send you a confirmation (though this is optional).

3. Inform the company

• Send a second copy of the 83(b) election to the company within the 30-day window via post or email – they need this for their records and tax purposes.

4. Include the election in your tax return

• When you file your income tax return for the year, include a third copy of the election with your state personal income tax return. This isn’t mandatory but can help document your filing.
• The fourth copy should be kept by you for your own records.

Getting the filing of your 83(b) election wrong could mean losing tax benefits you’re entitled to (and facing a bigger bill).

Why take the chance? You don’t have to do it all yourself – we can help you fill it in, ensuring that you do it correctly and avoid any potential pitfalls.

Our platform helps you create and file your 83(b) election quickly and correctly, saving you time and stress.

Ready to file your 83(b) election?

Getting the filing of your 83(b) election wrong could mean losing tax benefits you’re entitled to (and facing a bigger bill).

Our platform helps you to accurately create and file your 83(b) election. Speak to the team and they’ll take you through the process – quickly and efficiently.

Book a free call below and we’ll help you.

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