Note: The following information is relevant only for U.S. taxpayers. If you are not a U.S. taxpayer or are unsure about your tax situation, consult with a personal tax advisor about whether an 83(b) election is appropriate for you.

If you are a startup founder or an early employee, you have probably heard of the all-important 83(b) election. What is an 83(b) election, and why is it such a big deal?

The 83(b) election is a U.S. federal tax filing that is relevant when you buy or receive vesting shares of stock from a company. Filing an 83(b) election changes how the Internal Revenue Service (IRS) taxes your income from the shares. Most people who acquire vesting shares will prefer the tax treatment resulting from the 83(b) election over the default tax treatment.

Notice that the 83(b) election only applies to vesting shares of actual stock. You do not need to worry about 83(b) elections when you receive a stock option, even if the option is subject to vesting. A stock option is a right to buy shares of stock, but you do not have any actual shares of stock until you “exercise” the option and buy the shares. You should, however, think about the 83(b) election if you ever “early exercise” a stock option. By definition, early exercising a stock option means that you are buying shares of actual stock that are still subject to vesting. 83(b) elections are also not relevant to restricted stock units (RSUs), which, confusingly to many startup founders and employees, are not the same thing as restricted stock. RSUs are typically awarded to employees of later-stage, pre-IPO private companies and public companies.

You have 30 calendar days after the date you receive a stock grant or buy shares subject to vesting (the transfer date) to file an 83(b) election with the IRS. Do not put off the 83(b) election until the last minute. The 83(b) election is an inconvenient filing because it is not available to file online. You must mail it and the postmark date is how you know you made the filing on time. If you are acquiring vesting shares, fill out the 83(b) election paperwork and send it to the IRS as soon as you can to avoid a rush to the post office at the deadline.

Filing an 83(b) election and keeping good records of the filing will save time, money, and headaches for you and your company. Read on to learn how an 83(b) election can help you, how to file it, and what to keep as proof of filing.

Default Tax Treatment of Vesting Shares

1. U.S. federal tax law (Section 83 of the Internal Revenue Code) says that, by default, you owe income taxes on your shares in the year(s) that they vest, calculated each time they vest, on the following amount:

Taxable Income Upon Shares Vesting = Fair Market Value of the Vesting Shares - Amount Paid for the Vesting Shares

2. Under current U.S. tax law, if you hold shares for at least one year before selling, you pay a lower “long-term capital gains” tax rate on any profits. But with vesting shares, the default treatment is that the one-year holding period for long-term capital gains does not begin until your shares vest.
3. If you acquired your vesting shares from a company “in connection with the performance of services” and are employed by that company, the company has an employee income tax withholding obligation based on the taxable income calculation above each time your shares vest. 

Section 83(b) Tax Treatment of Vesting Shares

Section 83(b) of the Internal Revenue Code allows you to elect an alternative (and usually better) income tax treatment for your vesting shares. 

1. Making an 83(b) election tells the IRS that you want to pay all the income taxes on your vesting shares in the year that you acquire them. In other words, you would owe income taxes, calculated once as of the transfer date, on the following amount:

Taxable Income If You File an 83(b) Election = Fair Market Value of All Shares - Amount Paid for All Shares

2. Making an 83(b) election has the effect of starting the long-term capital gains holding period for all of your vesting shares on the transfer date.
3. If you acquired your vesting shares from a company “in connection with the performance of services” and are employed by that company, the company has an employee income tax withholding obligation, but if you make an 83(b) election, it is calculated once as of the transfer date.

What Does This Mean In Practice?

Making an 83(b) election will usually save you money on taxes. Typically, when you buy vesting shares as a founder or an early employee of a startup, the amount you pay for the shares is equal to their fair market value on the transfer date. In this situation, filing an 83(b) election means you would owe no taxes because there is zero taxable income; the fair market value of the shares and the amount paid for the shares cancel each other out.

If you receive vesting shares as a stock grant, the calculation changes. If you file an 83(b) election for a stock grant, you will likely owe income taxes in the year that you receive the stock grant. In this situation, the positive fair market value of the shares is not offset by the zero paid for the shares. Generally, the lower the fair market value of the shares you receive in the stock grant, the more advantageous it is to make an 83(b) election in this scenario.

Compare the above scenarios to not filing an 83(b) election. If you own shares in a startup subject to the standard Silicon Valley vesting schedule (monthly vesting over four years, with a one-year vesting cliff), and you do not properly file an 83(b) election, then each year, as your shares vest, you should expect to owe more income taxes as the fair market value of the shares increases as the startup’s business grows. You would also need to have cash ready to pay these taxes. Compared with the ease of buying and selling shares of public companies, you may find it difficult, if not downright impossible, to sell your startup shares to raise cash for the taxes that you owe on them. As your shares vest, if the startup has an employee income tax withholding obligation, it must deduct these amounts from your pay in order to remit these withholdings to the tax authorities in cash. If the company fails to meet its withholding obligations, it can be liable to state and federal authorities for any unwithheld taxes, interest, and possible penalties.

Startup investors and acquirers are keen to avoid this potential cascade of personal and business consequences from missed 83(b) elections. Lawyers representing these investors and acquirers will insist on seeing proof of timely 83(b) elections from everyone who has bought or received vesting shares from a startup. Missing or unfiled 83(b) elections can result in lower financing valuations, lower acquisition prices, and increased indemnities, as well as unnecessary scrambling, transaction delays, and increased transaction costs due to legal time spent resolving any 83(b) election issues.

When Might You Choose Not to Make an 83(b) Election?

There are a couple of unusual scenarios when you might save on taxes by not filing the 83(b) election:

1. If you are receiving vesting shares as a stock grant and you believe that the shares’ fair market value when they vest will be lower than their value on the transfer date. In this situation, not making an 83(b) election would mean that you could recognize lower taxable income when and as your shares vest. However, for this choice to bear fruit, the shares’ fair market value would need to be consistently lower throughout the vesting period than their value on the transfer date. Any higher and you would have been better off making the 83(b) election.
2. If you are receiving vesting shares as a stock grant and you think you might leave your job before many of your shares have vested. The nature of vesting shares means that you are required to return unvested shares to the company when you leave your job. If you file an 83(b) election, you pay taxes on all of your shares upfront, whether vested or unvested, and you can’t get a refund of the taxes you paid on your unvested shares when you leave your job. In this situation, not making an 83(b) election would mean that you could owe taxes only on the shares you can keep, as they vest, and no more.

Unfortunately, making the right call on whether to file the 83(b) election in either of these situations requires you to have a crystal ball or at least more certainty about the future than you are likely to have within the 30-day 83(b) filing limit. In these situations, you may be better off rejecting the stock grant or asking your company to give you shares in a different way, like as a stock option, instead of risking the consequences of a missed 83(b) election. As always, you should obtain independent professional tax advice to help with your specific situation.

How Do You File an 83(b) Election?

Even though the 83(b) election is such a common, important filing, it is inconvenient because you cannot submit it online. You must print, manually sign, and mail the 83(b) filing paperwork.

The company that sells or grants vesting shares to you will usually provide an 83(b) election form, a template cover letter, and filing instructions. Here is an 83(b) election form, and here are filing instructions and a template cover letter for your reference.

Complete the 83(b) election form and sign it in ink. The IRS does not currently allow electronic signatures, like DocuSign, for this filing. Some people complete and sign the 83(b) election form on an iPad and print it out, which seems to work fine if the printout is not pixelated.

Your 83(b) election mailing must be postmarked no later than 30 calendar days after the transfer date of your shares. This is a strict deadline that cannot be extended. The postmark date counts as the filing date.

Retaining proof of a timely 83(b) election filing is important. You should send the 83(b) election via certified mail, selecting the option for “return receipt requested,” and include an extra copy of the completed 83(b) election form and a self-addressed stamped envelope. The IRS will stamp the copy as “received” and mail it back to you. The IRS stamp looks like this:

Keep the IRS-stamped copy of the 83(b) election form when you receive it in the mail and share this filing evidence with the company that sold or granted the shares to you. You should also consider keeping other proof of filing, such as photographs of the completed 83(b) form and mailing envelope, screenshots of any tracking history, and the certified mail return receipt. These can come in handy if the IRS does not return a stamped copy to you, or the mail gets lost or delayed.