If you're a founder or early employee receiving company equity, the 83(b) election may be one of the most important tax strategies you need to understand.
One reason people join startups is the potential for growth. You put in years of hard work and hope your equity eventually becomes valuable through an acquisition, IPO, tender offer or another liquidity event.
But that growth can also create a significant tax bill. A Section 83(b) election may allow you to recognize income while the value of your shares is still low instead of paying ordinary income tax as the shares vest.
Anything named after a section of the tax code sounds complicated, so let's make this as simple as possible.
What is an 83(b) election?
An 83(b) election allows you to pay tax on restricted shares when they are transferred to you instead of waiting until they vest.
The taxable amount is the difference between the fair market value of the shares and the amount you paid for them. If you purchase the shares for their current fair market value, that difference, and your immediate taxable income, could be close to zero.
Imagine you receive 100,000 restricted shares worth $0.01 each. Their total value is $1,000. If you paid $1,000 for the shares and filed an 83(b) election, you may have no taxable income from the transaction.
Now imagine those shares are worth $10 each by the time they vest. Without an 83(b) election, you could recognize ordinary income as the shares vest based on their much higher value at that time.
With a properly filed election, future appreciation generally isn't taxed as compensation when the shares vest. You would instead recognize a capital gain or loss when you eventually sell them.
Avoiding a phantom-income problem
An 83(b) election may also help you avoid what can feel like phantom income.
Your private-company shares could increase substantially in value and then vest. Without an 83(b) election, that value may be treated as taxable compensation even though you can't sell the shares.
You received something valuable on paper, but you didn't receive any cash.
For example, restricted shares worth very little at grant could be worth $500,000 when they vest. That vesting event could create a large tax bill even if the company is still private and there is no liquidity event in sight.
Recognizing the income earlier, while the shares are worth very little, may prevent a situation where you owe taxes on hundreds of thousands of dollars of illiquid stock.
Starting the QSBS clock earlier
An 83(b) election may also start the holding period for qualified small business stock, or QSBS. If your shares qualify, the election may start your holding period when the restricted shares are transferred to you instead of waiting for each portion to vest.
This can move the clock forward by several years.
Under the current rules, qualifying shares acquired after July 4, 2025 may be eligible for a 50% federal gain exclusion after three years, a 75% exclusion after four years and a 100% exclusion after five years.
An 83(b) election doesn't automatically make your shares QSBS. The company and shares must still meet all the Section 1202 requirements. But when the shares qualify, starting that holding period earlier could eventually help you exclude millions of dollars of gains from federal taxes.
Who can use an 83(b) election?
This strategy primarily comes into play for founders and employees receiving restricted stock awards or early-exercisable stock options.
Restricted stock awards, or RSAs, are actual shares transferred to you. You own the shares, but the company may have the right to take back the unvested portion if you leave before the end of your vesting schedule. Because actual shares have been transferred, you may have the opportunity to file an 83(b) election.
Restricted stock units, or RSUs, are different. An RSU is generally a promise that the company will deliver shares or cash after certain vesting conditions are met. Because you usually haven't received actual shares at grant, you generally can't file an 83(b) election on standard RSUs. The names sound similar, but the tax treatment is very different.
What about early-exercisable stock options?
Some startups allow employees to exercise their stock options before the options vest. You pay the exercise price and receive actual shares, but the unvested shares remain subject to the company's repurchase rights. Because the shares have been transferred to you, you may be able to file an 83(b) election after the early exercise.
With nonqualified stock options, or NSOs, the difference between the fair market value and exercise price is generally treated as ordinary income. Early exercising while that difference is small may help minimize the income you recognize.
Incentive stock options, or ISOs, are more complicated. An ISO exercise generally doesn't create regular taxable income, but it can affect the alternative minimum tax. An 83(b) election may still be relevant for AMT purposes when unvested ISO shares are early exercised.
What are the risks?
The 83(b) election comes with real risks.
You may leave the company before your shares vest, or the company may never complete a successful exit. If the shares are forfeited or repurchased, you generally can't recover the taxes you paid because of the election.
If you're early exercising options, you also need cash to purchase shares that may never become liquid. Once the election is filed, it generally can't be revoked without IRS consent.
You're making a bet that the company will appreciate and that you'll remain there long enough for the potential tax benefits to outweigh the upfront cost and risk.
How do you file an 83(b) election?
You must file the election with the IRS no later than 30 days after the restricted shares are transferred to you. For restricted stock, this may be the date the shares are issued. For early-exercised options, it is generally the date you exercise and receive the shares, not the original grant date.
The IRS now provides Form 15620, Section 83(b) Election. You can currently submit it online or mail it to the appropriate IRS office. You must also provide a copy to the company and keep proof of timely filing with your records.
Missing the 30-day deadline can eliminate the opportunity.
Should you file an 83(b) election?
An 83(b) election is generally most attractive when the current share value is low, the purchase price is close to fair market value and you expect the company to grow significantly.
You should also consider how long you expect to remain at the company, whether the shares may qualify for QSBS and whether you can afford the exercise cost and immediate tax.
The basic idea is simple: You're accepting some risk today for the opportunity to reduce future ordinary income, avoid a potential phantom-income problem and start important holding periods earlier.
When the facts line up, the tax savings can be substantial.
If you recently received restricted stock or are considering an early exercise, feel free to schedule a complimentary strategy session to discuss your equity and tax-planning options.
