83(b) Elections: Guide, Benefits, Risks & Tax Tips

Navigating the world of equity compensation? Form 83(b) elections might be your secret weapon. This tax strategy allows you to pay taxes on the total fair market value of restricted stock at the time of granting, potentially saving you money in the long run. 

As someone who has invested in dozens of early-stage startups, I’ve seen firsthand how this tax strategy can save money in the long run. Let’s explore how and when to make this savvy move.

Understanding Form 83(b) Elections and Tax Implications

The 83(b) election is a provision under the Internal Revenue Code that allows individuals, such as employees or startup founders, to pay taxes on the fair market value (FMV) of restricted stock at the time it is granted, rather than when it vests. 

By filing an 83(b) election, you agree to pay taxes on the difference between the FMV of the stock and its purchase price at the time of grant. For instance, if you receive 100,000 shares at an FMV of $1.00 per share and pay $0, your taxable income would be $100,000. This pre-payment of taxes locks in the current valuation of your stock for tax purposes, which can lead to significant savings if the stock appreciates over time.

As per EA Tax Manager, Reid Kopald,  “Filing an 83(b) election is like betting that the value of your stock will increase – think of it as paying your taxes while the stock is still in its infancy.”

Without an 83(b) election, taxes are deferred until the stock vests. At that point, you would pay taxes on the difference between the stock’s FMV at vesting and its purchase price. This can potentially result in a higher tax liability if the stock’s value has increased substantially.

This strategy can potentially save money if the stock appreciates over time, but it also involves a risk: if the stock’s value decreases, the individual would have paid taxes unnecessarily. The tax paid at the grant is not refundable. For example, if the stock appreciates significantly, the long-term capital gains rate could result in lower taxes upon sale, potentially saving money in the long run.

Step-by-Step Guide to Filing Form 83(b) with Professional Guidance

Filing an 83(b) election is crucial for startup employees, founders, and investors in growth, venture, and private equity. Here’s a comprehensive guide to filing Form 83(b), enriched with the benefits of seeking expert advice.

Step 1: Complete the IRS 83(b) Form

The first step is to fill out the IRS Section 83(b) form. On November 7, 2024, the IRS introduced Form 15620, a new standardized form for taxpayers opting to make a Section 83(b) election.

This requires details such as:

• Personal information, e.g. your name, address, Social Security number
• A description of the property awarded, e.g. number of shares purchased, type of stock issued
• Date of property transfer 
• The amount of gross income to be indicated on the income tax return

You can download the form directly from the IRS website or obtain it from your employer.

Professional Tip: Consult a tax advisor to verify the accuracy of your information and clarify any uncertainties.

Step 2: Sign the Form

Once completed, sign the form. The IRS accepts both digital and handwritten signatures, so choose whichever is most convenient.

Professional Tip: Keep a digital backup of the signed form for added security.

Step 3: Create Multiple Copies

Prepare three copies of the signed form:

• One for the IRS.
• One for your employer.
• One for your personal records.

Extra copies ensure you have documentation to resolve any future disputes.

Step 4: Mail the Form to the IRS

Send the original signed copy to the IRS Service Center where you file your taxes. The election must be filed within 30 calendar days after the transfer of property. This means you have 30 days from the date you receive the stock to file the election. 

This is a strict deadline, and missing it can result in losing the potential tax benefits associated with the election. If the 30th day is a weekend or holiday, the deadline is the next business day. 

To ensure your 83(b) election is considered timely, use the Certified Mail with Return Receipt. This provides proof of timely mailing, which is crucial since the IRS does not always confirm receipt. Keeping a copy of the election and the certified mail receipt can save you from future headaches.

Professional Tip: You can seek help from advisors to help determine the correct IRS Service Center and provide templates or checklists to streamline the process.

Step 5: Notify Your Employer

Mail one copy of the completed form to your employer. This ensures they have accurate records for their own tax filings and avoids potential disputes.

Professional Tip: You can send a formal notification letter alongside the form to establish clear communication with your employer.

Step 6: Retain Documentation

Keep a copy of the signed form, the Certified Mail receipt, and any confirmation from the IRS. Scanning or photographing these documents ensures you have backup copies in case of loss or damage.

Professional Tip: Create a secure digital file for easy access during tax preparation or in case of an audit.

Benefits and Applications of 83(b) Elections for Startup Employees

The 83(b) election offers substantial advantages, particularly for startup employees and founders. By understanding both the benefits and practical scenarios, you can make informed decisions about how to manage your equity compensation effectively.

Here’s how the 83(b) election helps you maximize your benefits:

Tax Savings

Filing an 83(b) election allows taxpayers to pay ordinary income tax on the fair market value of the stock at the time of grant, rather than at the time of vesting. This upfront taxation can potentially reduce the overall tax burden. 

However, any future gains from the sale of the stock will be taxed at the lower long-term capital gains rate, which can result in significant tax savings if the stock appreciates over time.

Favorable Tax Treatment on Gains

As per Investopedia, the income rate in the US ranges from 10% to 37%, while the capital gains rate ranges from 0% to 20%. 

When you file an 83(b) election, you lock in the opportunity to have future stock appreciation taxed at the lower long-term capital gains rate instead of the higher ordinary income tax rate. This can lead to considerable savings as your equity grows in value over time.

Flexibility and Protection

Life in the startup world is unpredictable, and so is the value of your stock. The 83(b) election provides flexibility to manage your tax liabilities effectively. If the stock’s value decreases before vesting, you may even be able to deduct losses, giving you an additional layer of financial protection against potential risks.

Risks and Mistakes to Avoid with 83(b) Elections

While the 83(b) election offers significant benefits, it’s not without risks and potential pitfalls. Understanding these challenges and avoiding common mistakes is essential to ensure you maximize the advantages of the election while minimizing financial and procedural errors.

Key Risks 

Here are some of the risks to consider before filing:

Potential Overpayment

One of the primary risks of filing an 83(b) election is the potential for overpayment of taxes. If the value of the company declines consistently after the election, you may have paid taxes on a higher equity valuation, leading to financial loss. This risk is particularly pronounced if the stock’s value never recovers or if the company underperforms.

Complex Filing Process

The process of filing an 83(b) election can be intricate and requires careful attention to detail. Mistakes in filing or failing to fully understand the requirements can lead to missed deadlines or lost tax benefits. Enlisting the help of a tax advisor or using a reliable template is often necessary to navigate the process successfully.

Deadline Sensitivity

Missing the strict 30-day deadline to file the election with the IRS is one of the most critical errors. If the deadline is missed, the election is invalid, and you lose the opportunity for tax savings, potentially resulting in higher tax liabilities.

Common Mistakes to Avoid

Here are the most common pitfalls and how to avoid them:

• Missing the Filing Deadline: Filing must be completed within 30 days of the grant date. This deadline is non-negotiable, so it’s crucial to act quickly and have all required documents ready.
• Providing Inaccurate Information: Double-check all details on your 83(b) election form, including the number of shares, their fair market value (FMV), and the purchase price. Errors in this information can lead to complications and disputes later.
• Failing to Use Certified Mail with Return Receipt: Always use Certified Mail with Return Receipt when submitting your 83(b) election. This ensures you have proof of timely filing, which is critical if there are any disputes about when the election was submitted.
• Not Notifying Your Employer: Neglecting to send a copy of the 83(b) election to your employer can result in incomplete tax records and misunderstandings about your equity compensation. Always provide a copy to your employer to maintain clear and accurate records.

Professional Tip: Start the filing process immediately after your stock grant to avoid last-minute issues.

Alternatives to Filing an 83(b) Election and Other Key Considerations

While filing an 83(b) election can provide significant tax advantages, it’s not the right choice for everyone. Understanding the alternatives and other key factors related to equity compensation can help you make an informed decision about how to manage your financial future.

Alternatives to Filing an 83(b) Election

Not filing an 83(b) election is a valid choice for some, but it comes with its own set of financial implications. Here’s what you need to know about the potential consequences and how they might impact your equity compensation strategy.

No 83(b) Election

Opting not to file an 83(b) election means you will include the value of your restricted stock in your taxable income as it vests, rather than at the time of grant. This approach can result in what is known as “phantom income,” where you are taxed on the stock’s value even if you haven’t sold it. For more in-depth information on this, you can check out phantom or shadow equity and its implications. 

For example, Christopher, a programmer who received an equity stake in his company, chose not to file an 83(b) election. As his company’s shares increased, he had to report the growing value of his taxable income annually. This significantly increased his tax burden, as the income was taxed at ordinary income rates, often higher than the capital gains rates he could have secured by filing the election.

Increased Tax Burden Over Time

Without an 83(b) election, the rising value of your stock can push you into higher tax brackets as the stock vests. This is particularly impactful in high-growth industries like venture capital or private equity, where equity stakes can appreciate rapidly.

For example, a founder who receives nonqualified stock options as part of their compensation package may face a hefty tax liability during each vesting period. The value of the options is included in their taxable income, which can result in significant financial strain, particularly if the stock’s value skyrockets over time.

Additional Considerations

Filing an 83(b) election isn’t just about understanding tax rules—it also involves navigating various logistical and legal factors. From filing requirements to state-specific laws, here are some additional considerations to keep in mind.

Electronic Filing

As of now, the IRS does not permit electronic filing of Form 15620 for 83(b) elections, requiring all submissions to be mailed. However, electronic filing may become mandatory in the future. Staying informed about these changes is essential for individuals involved in equity compensation, as it may impact how you prepare and file your election.

Community Property States

In community property states like California, Texas, or Arizona, property ownership is generally governed by community property laws, which affect how property is divided in a divorce or upon death. However, these laws do not impact the filing requirements for an 83(b) election. 

The 83(b) election form is a document filed with the IRS by the individual taxpayer receiving the restricted property, such as stock, to report its fair market value at the time of grant. It does not require the signature of both spouses, even in community property states.

Company Requirements

Some companies have specific filing requirements for employees or founders opting to file an 83(b) election. For instance, they may require you to provide a copy of the signed form for their records. Understanding these requirements is essential to avoid administrative complications and ensure compliance with company policies.

Importance of Strategic Planning

Filing an 83(b) election—or choosing not to—should be part of a broader financial strategy. Consulting with professional advisors, such as tax consultants or financial planners, can help you understand complex terms like:

• Strike prices
• Warrants vs. options
• Qualified Small Business Stock (QSBS)

With the right guidance, you can minimize your tax liabilities and maximize the financial benefits of your equity compensation.

Rescinding the Election

Keep in mind that an 83(b) election cannot be rescinded without the consent of the IRS Commissioner. The IRS may grant consent to revoke an election under specific circumstances, such as a mistake of fact, but this is not a standard procedure and must be requested within 60 days of when the mistake first became known.

Examples and Case Studies

To illustrate the impact of an 83(b) election, consider the following examples

Scenario 1: High Appreciation

Imagine being at the forefront of a promising startup. You receive 4 million shares of restricted stock with a grant date FMV of $0.85 per share. By filing an 83(b) election, you report $3.399 million in taxable income and owe approximately $1.7 million in taxes upfront. While this may seem daunting, the benefit lies in locking in the stock’s current valuation. 

Future appreciation will be taxed at the capital gains rate, offering substantial savings compared to paying ordinary income taxes on a higher valuation when the shares vest. Without the election, taxes at vesting could result in a much larger tax burden.

Scenario 2: Moderate Appreciation

Let’s say you receive 100,000 shares at an FMV of $1.00 per share with a purchase price of $0. Filing an 83(b) election results in an ordinary income tax payment of $370 upfront. 

Any future gains are taxed as capital gains, potentially leading to a sizable after-tax economic gain of $399,830 when the stock is sold. Without the election, however, you might face a higher tax liability at vesting if the stock appreciates significantly.

Scenario 3: Low Appreciation

If the stock’s value is not expected to rise dramatically, you might opt not to file an 83(b) election. For example, if you receive 100,000 shares at an FMV of $1.00 per share and pay $0, deferring taxes until vesting could be advantageous. This approach allows you to manage your tax liability more effectively and avoid pre-paying taxes on a stock that may not appreciate much or might even decline in value.

Scenario 4: No Election

Without an 83(b) election, the employee would pay tax on the vesting date, potentially at a higher tax rate. This could result in a larger tax hit, especially if they do not have cash available to pay the tax. The 83(b) election can help avoid this scenario by locking in the current value for tax purposes.

Scenario 5: Restricted Stock

An employee receives restricted stock worth $1,000. By filing an 83(b) election, they pay an ordinary income tax of $370 (37% of $1,000). Later, when the stock vests, they do not have to pay additional tax, but they recognize a taxable gain on sale at a lower rate. This can result in significant tax savings if the stock’s value increases.