Congrats! You were just granted equity in a startup. But… now what? If you are new to the startup ecosystem, or just not fluent in the regulation of privately held securities (as many are not), you might overlook a key consideration which impacts the tax treatment of your new equity: the 83(b) election.
Taxes may not be top of mind for founders and employees when they’re in the early stages of building the next unicorn, but it’s important to remember that stock is taxable and, if you don’t pay the fair market value for your equity at the time of grant, you may be surprised by the tax treatment when you go to sell your equity down the road. Even more importantly, if your stock is subject to vesting, it is taxable at each vesting milestone for the duration of the vesting schedule.
A common example of how this might apply is a restricted stock grant included in a compensation package for a startup’s first employee. Say Emmy Employee was granted 2% of Startup Inc.’s equity, vesting over a four-year term, with a one-year cliff. Emmy earns her equity through services rendered to the company, so she is not required to pay any cash when she receives her equity award. When she reaches her one-year cliff (after working at Startup Inc. for one year), 25% of her equity grant vests, and the fair market value of that equity at that time will be taxed as ordinary income. Her stock vests in equal monthly installments for the next thirty-six months, and at each of those vesting installments, the newly-vested equity will be taxable at the then-present value of the stock. If Startup Inc.’s growth is slow and steady, Emmy may not mind paying incremental taxes on her equity, as the value of that equity will continue to be quite low, which will keep her tax hit low. But if the company accelerates in year two or three, causing the value of the stock to increase substantially, Emmy will be left with a large tax burden at the end of the year unless she filed an 83(b) election when she received her equity grant.
What is an 83(b) Election?
An 83(b) election is a tax filing made by the stockholder which allows them to be taxed on the fair market value of their equity grant at the time of grant, rather than when the stock vests. It also starts the holding period for determining whether the capital gain on the stock is considered long-term or short term, instead of tying the holding period to the date of each vesting installment, which can impact the taxes on a future sale or disposition of the stock. To be effective, the 83(b) election filing must be submitted to the IRS within 30 days of the of the date of grant from the company.
What Types of Equity Qualify?
83(b) elections generally apply to unvested equity, including equity grants like restricted common stock and early-exercise common stock options (if the optionee opts to utilize the early exercise). Note that 83(b) elections do not apply to installment exercise stock options, as these can only be purchased once they have vested. Founders, employees, and independent contractors of the company can all make 83(b) elections; the category of the stock grant determines eligibility, not your relationship with the company.
How to File an 83(b) Election
In October of 2024, the IRS released Form 15620, which is a standardized 83(b) election form. Note that before the release of the Form 15620, companies would often use their own template for 83(b) elections, and those templates can still be used so long as they include the same information delineated in the IRS form. Once the form is completed, it should be signed or e-signed, printed and mailed to the IRS office with which you file your federal income tax return. Although it is not required, it is advisable to send the filing via certified mail, return receipt requested. To comply with the 30-day filing requirement, your 83(b) election must be stamped and postmarked within 30 days of the date that the stock was first granted to you. Once you have mailed your election form, you should share a signed copy with your employer and maintain a copy for your own records along with your proof of mailing.
While an 83(b) election can be very beneficial to those holding startup equity, there are also risks associated with the filing (like a situation in which a stockholder exits the company before their stock has fully vested, so the stockholder has paid taxes on stock that it does not own), so you should always consult with your tax advisor when considering whether or not an 83(b) filing is the right choice for you.
