83(b) Elections – The IRS’s SUPER-SAVER COUPON
Time to read - 10 minutes
This article will explore Section 83(b) elections, how they apply to founders equity, and if you didn’t file one are you screwed?
You should come away with the fact that if you have received unvested shares for a nominal value within the last 30 days, then take the time to fill out the IRS’s 83b form. Hint – this article also tells you how to do that.
What is an 83(b) Election for Startup Founders?
Matthew Bartus from Cooley makes great use of the analogy of an expired coupon at the grocery store when discussing 83b elections here or this article on Avvo.
If you didn't fill out the 83b election, it is like walking up to pay for your groceries and pulling a coupon out of your pocket only to realize it has long-since expired.
The IRS is not going to honor the coupon.
So what is a Section 83(b) election? It’s a letter you send to the IRS letting them know you want to be taxed right now!
Sounds strange right - why would you ever want to be taxed early? Hang in there with me for one more moment.
You tell the IRS to go ahead and tax you on the FMV of the unvested shares you just received. If you set the FMV of those shares low, like most founders i.e. 0.0001 per share, then the tax should not be a major hit.
The tax you will pay is minimal comparatively if you have the next Facebook.
Wouldn’t you much rather be taxed on 0.0001 per share than $10 or $100 per share on the date the equity vests or later sales?
What if my Stock is Unrestricted?
Section 83(b) elections only apply when stock is subject to vesting. A grant of fully vested stock will be taxed at the time of the grant.
Meaning, if you are a solo founder and issued yourself 1,000,000 shares of unrestricted stock paid for with contributions to the corporation, then 83(b) elections are not an issue. Unless and until you give unvested shares to a cofounder or new employee.
Failed to file 83b, missed deadline, what are my options?
If the sound of accelerated ordinary income tax didn't have a nice ring to it. Or you were too busy working, that the first 30 days slipped by, without you filing an83b election form, here is what happens.
When a founder fails to make a 83(b) election, each vesting milestone is treated as a taxable event. This means the IRS will see it as if you have received income whenever your stock vests.
The IRS will calculate this “income” as the difference between the FMV of the portion of stock that vested and the original purchase price of the newly-vested portion.
Consequence - failure to make an 83(b) election could leave you facing massive tax bill without experiencing a liquidity event. Meaning you could be paying the IRS with cash that could be used to grow the business.
The 30 day deadline is absolute that cannot be cured.
WTF is the Capital Gains Tax Rate Anyway?
If you are reading this article you have likely heard of the ordinary income tax rate and the long-term capital gains rate. If not, here is a quick refresher.
The maximum ordinary income tax rate is roughly double the long-term capital gains rate! 39.6% vs. long-term capital gains rate of 20%.
Suffice to say, even if your graduated tax rate is lower than 39.6%, the long-term capital gains rate will still be much lower than your ordinary income tax rate.
Additionally, the making of the Section 83(b) election starts the founder’s capital gains holding period. Meaning that you get the long-term capital gains rate as long as you sale your shares more than one year after the grant.
Let’s Walk Through Some Fun Tax Examples
Let’s say you filed your corporations article on June 1 through LegalZoom and issued 1,000,000 restricted (unvested) shares the same day.
The first example, assumes you heard from a friend about the 83b form and some sort of 30 day deadline. You read this article and filed your 83(b) election.
The second example assumes you don't have as many friends and/or you don't troll the internet as hard as you should.
A Few Other Assumptions
Each share worth $.0001 at the time of grant
$0.30 per share at the time of vesting
$1.00 per share when sold > year later.
Maximum ordinary income tax rate and long-term capital gains rate.
No other tax consequences.
Teddy – 83(b) Election
In this example Teddy timely filed a Section 83(b) election within 30 days. His shares were worth $100. He pays ordinary income tax of $39.60 (i.e., $100 x 39.6%).
Because he filed a Section 83(b) election he will pay taxes on the later sale. Huge win for Teddy! On the later sale which occurs more than one year after the date of grant he recognizes a taxable gain of $1 per share and pays additional tax of $200,000 (i.e., $1,000,000 x 20%).
Will – No 83(b) Election
In this example Will did not file a Section 83(b) election. He pays no tax at grant, but recognizes income of $300,000 when the shares vest and thus will have an ordinary income tax of $118,800!!
Note – this is the major issue, because this $118,000 could cause the business all sorts of headaches if he has to sell shares to pay for the tax.
On the later sale, Will will recognize a taxable gain of $0.70 per share (not $1.00, because he gets credit for the $0.30 per share he already took into income), and pay additional tax of $140,000 (i.e., $700,000 x 20%).
Should I file an Section 83(b) election?
If you have received unvested shares for a nominal value within the last 30 days, then take the time to fill out the IRS’s 83b election form.
However, what if you received shares with substantial value, be careful. Because if you file an 83(b) election you will be taxed now at the ordinary income tax rate for those shares. Meaning it could cause an immediate tax hit.
You are making a lot of predictions and bets in your early stage company (nature of startups), make sure you discuss the potential consequences with your attorney, tax advisor, and potentially your fortune teller or tarot card reader.
Instructions for Filing a Section 83(b) Election
The instructions below are meant to be a quick snapshot. Make sure you have an attorney or accountant review you 83(b) election before filing.
STEP 1. Complete four copies of the 83(b) election.
On all 4 copies of the 83(b) election, review, date, manually sign and insert the taxpayer identification number for the taxpayer (and spouse, if applicable).
STEP 2. Send two copies to the IRS.
Send two copies to the IRS by USPS Certified Mail with Return Receipt requested. Use the mailing address for the IRS office where the taxpayer files his or her income tax return.
Although sending a second copy of the 83(b) election is not mandatory, it is recommended that taxpayers include it with a self-addressed, postage-paid envelope and request the IRS return it with a date-stamp for record-keeping.
STEP 3. Deliver one copy of the completed election form to the Company.
STEP 4. Consult personal tax advisor(s) to determine whether or not a copy of this Section 83(b) election should be filed with your state personal income tax return(s).
STEP 5. Keep one copy for your taxpayer records.
This article was written by Curtis Roberts, an attorney at The Founder's Attorney.
If you have any questions or suggestions he can be reached at curtis@foundersattorney.com.
This article is for general information and entertainment purposes only. The views of the author are their own and do not represent the views of The Founder's Attorney. The information presented should not be construed to be formal legal or financial advice nor the formation of a lawyer/client relationship or any fiduciary duty.