83(b) Elections

When shares are subject to vesting, by default, the IRS treats it as a taxable event every time a portion of the shares vest. This means that whenever you have shares of stock vesting, the IRS considers as taxable income the difference between (1) the fair market value (FMV) of those shares at that time and (2) the price you paid for those shares.

For founders of successful startups, this can lead to a significant increase in taxes as the FMV of their stock increases. The taxable income is tied up in the form of illiquid stock, which makes it difficult for founders to be able to afford the tax increase. In addition, the process is likely to be a significant burden due to the number of times the FMV would need to be determined. For example, for 4-year straight-line vesting, the FMV would need to be determined 48 times.

Fortunately, the IRS allows recipients of restricted stock to elect alternative tax treatment through an 83(b) election. If you make an 83(b) election, you can disregard the vesting for tax purposes and consider the purchase of the stock to be the only taxable event. You would then recognize the difference between (1) the FMV of all the shares at the time you purchased the stock and (2) the price you paid for those shares as income for the current tax year. Founders typically purchase their shares at FMV, so if they make an 83(b) election, they typically do not have any taxable income from the purchase of the shares.

In order to make a valid 83(b) election, you must manually sign the 83(b) election (the IRS does not accept electronic signatures for 83(b) elections) and mail it to the appropriate IRS office within 30 days of the stock issuance. It is critically important to make the 83(b) election on time, as there is no easy way to fix a missed deadline for 83(b) elections.1

IRS regulations also require you to provide a copy of your 83(b) election to the company. As a founder, providing a copy to the company can be as simple as emailing a copy to your co-founders (if any). It is considered a best practice to store copies of all 83(b) elections in the company's records.

In addition to making a valid 83(b) election, it is important to get evidence that you've done so. VCs and potential acquirers will look for this evidence as part of the legal due diligence process, because missed 83(b) elections can cause startups a lot of problems down the line.

In order to get all possible evidence, most attorneys recommend mailing the 83(b) election to the IRS via USPS certified mail with return receipt requested. You should then retain the certified mail receipt as well as the return receipt when it comes back to you. In addition, most attorneys recommend including a request for the IRS to acknowledge receipt of your 83(b) election. In order to do this, you should include a brief letter to the IRS, along with a copy of your 83(b) election and a self-addressed, stamped envelope. The IRS will then typically stamp the copy and send it back to you. Unfortunately, the IRS occasionally neglects to do this (or it gets lost in the mail), which is why it is important to retain the certified mail receipt and return receipt.

If you miss the deadline, you should speak with an attorney immediately to determine next steps. Unfortunately, the legal bill for addressing this matter will likely dwarf the cost of a standard corporate formation.

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