Browse > Home / Founders / What is an 83(b) election?

What is an 83(b) election?

February 15, 2008

Failing to make a timely 83(b) election with the IRS is something that could lead to disastrous tax consequences for a startup company founder or employee.

Founders typically purchase stock pursuant to restricted stock purchase agreements that allow the company to repurchase “unvested” stock upon termination of employment. Similarly, employees may “early” exercise options subject to the company’s ability to repurchase “unvested” shares upon termination of employment.

Under Section 83 of the Internal Revenue Code, the founder/employee would not recognize income (the difference between fair market value and the price paid) until the stock vests. However, if a founder/employee makes a voluntary Section 83(b) election, the founder/employee recognizes “income” upon the purchase of the stock.

Typically, the purchase price for the stock and the fair market value are the same. Therefore, if an 83(b) election is made, there is no income recognized. Thus, a founder/employee should almost always make an 83(b) election. The benefits of an 83(b) election generally are starting the one year capital gain holding period and freezing ordinary income (or alternative minimum tax) recognition to the purchase date.

If the founder/employee does not make the 83(b) election, then he or she may have income at the stock “vests.” The income will be substantial if the value of the shares increases substantially over time.

For example, assume that a founder purchases stock for $0.01 per share (fair market value is $0.01) and the stock is subject to four year vesting with a one year cliff. The founder does not make an 83(b) election. At the end of the one year cliff, if the stock is worth $1.00/share, then the founder would recognize $0.99/share of income. As the remaining stock vests each month, the founder would recognize income equal to the difference between the fair market value and $0.01/share. In addition, the company is required to pay the employer’s share of FICA tax on the income and to withhold federal, state and local income tax.

If the founder had made an 83(b) election, the founder would not recognize any income as the stock vests, as the 83(b) election accelerates the timing of recognition of income to the purchase date.

In order for an 83(b) election to be effective, the individual must file the election with the IRS prior to the date of the stock purchase or within 30 days after the purchase date. There are no exceptions to this timely filing rule. The last possible day for filing is calculated by counting every day (including Saturdays, Sundays and holidays) starting with the next day after the date on which the stock is purchased. For example, if the stock is purchased on May 16, the last possible day for filing is June 15. The official postmark date of mailing is deemed to be the date of filing. The election should be filed by mailing a signed election form by certified mail, return receipt requested to the IRS Service Center where the individual files his or her tax returns. If the election is mailed after the 27th day, the individual should hand deliver the letter to the post office to obtain an official date-stamp on the certified mail receipt. A copy of the election should be provided to the company, and another copy should be attached to taxpayer’s federal income tax return for the year in which the property is acquired.

Written by Yokum · Filed Under Founders 

Comments

  • Guest
    Hi Yokum,

    I filed an 83(b) election within 30 days at the Fresno, CA's IRS Service Center although, as a non-resident, I need to file my 1040-NR at the Austin, TX's Center. Is there anything I can do about it?

    Thanks!
  • sheron74
    Hi Yokum,

    Thank you for your great effort to maintain this site which is extremely helpful.

    According to your posts, can I say employees who early exercise ISOs and file 83(b) election will be subject to AMT report, and income tax report at time he sells the shares acquired? If employee chooses not to early exercise ISO, my understanding is he does not need to report income tax at time of exercise, but need to report income tax at time he sells the shares.

    If this is true, it seems early exercise of ISO with 83(b) election will not benefit employees in most of cases except it starts accruing time period earlier for long-time investment purpose. Plus, there is risk of double tax.

    I am green in this area, please correct me if I am wrong
  • @sheron - please check with your own advisors and read the disclaimers. If there is no "spread" (difference between exercise price and fair market value) at the time of exerise of an ISO, then there will be no AMT preference. Please see the following post for an explanation of the differences between exercise of an ISO and NSO. Generally speaking, a person will be better off with an NSO if he/she will exercise when there is no spread. http://www.startupcompanylawyer.com/2008/03/05/...
  • Darryl G
    My situation seems typical but not covered here/in comments.

    I'm not a founder in the startup I am working for but I was issued employee options. I'm about to leave the company having already worked past my 1 year cliff - and so essentially I will have to exercise the options within 30 days of my last day.

    (I didn't elect to vest early but just signed my options agreement - which seems common among regular employees. Maybe that was the wrong decision?)

    Given where I am now, can you tell me where I stand with regards to 83b election? Can I still make the election when I exercise my options or am I too late?

    Many thanks
  • @Darryl - please check with your own advisors and read the disclaimers. If you are exercising fully-vested stock and there is no right of repurchase, then there is no need to file an 83(b) election.
  • Darryl G
    If there is no need to file an 83(b)... does that mean there is no way to avoid the tax created?

    Also, given the above when I start at the next startup I am about to join (as an employee), would I be in a better situation if I elected to exercise my options early and submit an 83(b)?

    Thanks for this great resource,
  • janebouffard
    My husband filed a 83(b) with our year 2000 taxes after purchasing $15,000 worth of common stock in his startup (there were lots of preferred stocks too). The company sold in 2009 for peanuts and no common shareholders got anything. I am assuming we can take a 3,000 capital gain loss for the next 5 years. Is that correct? Also I have no paperwork yet. What will I need?
  • @Jane - please consult with a tax advisor. You will need some documentation from the company that the common stock was rendered worthless.
  • Chad
    What if I e-File? How do I attach the form?
  • wktaylor66
    I sold my single member LLC to Company A (which is private, closely-held and incorporated), in exchange for an adjustable promissory note, shares of restricted stock (not founders shares) AND an employment agreement.

    Per the buy-sell agreement, the shares I received are subject to a vesting schedule AND substantial risk of forfeiture for certain circumstances which are concurrently covered under my employment agreement with Company A.

    I received shares in exchange for the sale of the assets of my business, not necessarily for services rendered - although I have previously rendered services to Company A and I am currently rendering services to Company A on an ongoing basis, per my employment agreement.

    I filed the Section 83b election via certified mail within 30 days of signing the agreement and claimed a value of $____ which I calculated based on the shares I received multiplied by the recent accounting valuation.

    After reading through the posts, I'm wondering if I could have assigned a value of $0 to my shares since I did not pay for my shares. If I could have/should have assigned a value of $0, can I amend my return?

    I've been told that given my unique circumstances, that I could claim the value of the shares received as LTCG to the extent that the value received exceeds my cost basis. I could subsequently report the future sale of my restricted shares as a LTCG based on the difference between the original value of the shares received and the sales price.

    I'm sure I need to consult with a tax advisor and/or an attorney but I would be grateful for your opinion on the matter.

    Regards,

    KT
  • @KT - I punt to tax advisors.
  • suebe71
    What if I am given stock (that is vested immediately) and there is no market yet (product is still in R&D) for the stock and the company net worth is minimum? Does my income relate to the book value per share I receive? ie $1.00 per share book value @ 4,000 shares...$4,000 income to declare.
  • @suebe71 - if you receive stock as consideration for services, you should report the FMV of the stock as income. Please check with your own tax advisors and read the disclaimers.
  • ramsj
    great post, are the filing timing requirements (i.e., must be postmarked by the end of the 30 days) in the regs for 83(b) or somewhere else?
  • @ramsj - it's in the regs.
  • sterlingtax
    What if you are not sure if the stock is restricted or there is a substantial risk of forefeiture,, should you make the Section 83(b) anyway?

    What would the penalty be if , down the road, it is found, that Section 83(b) was not applicable?
  • @Sterlingtax - Seems kind of silly if you don't know whether the stock is subject to forfeiture or not. The recipient of the stock either signed or didn't sign a document that put a repurchase right on the stock. I suspect that there is no particular penalty in filing an 83(b) in a situation where an 83(b) could not have been filed. Please read the disclaimers and discuss with your own tax advisors.
  • ScottJab
    Hi Yokum - Great post!

    We are thinking of issuing Founders shares to an LLC that is jointly owned by the Founders (rather than to us in our individual capacities). Are there any issues/problems with subjecting restricted stock to vesting when that stock is held by an entity, rather than the Founders themselves? I assume the entity will need to file an 83(b) as well.

    thanks!
  • scottjab
    HI Yokum - Great post!

    If Founders' Common shares that are subject to vesting are issued to an LLC that is 50% controlled by each Founder (rather than to the Founders directly), should an 83(b) be filed as well? Taking a step back, is it OK to subject these founders shares that are held by the LLC to vesting?

    thanks!
  • @Scott - It's okay to to subject shares held by the LLC to vesting. I suspect that the LLC can/should make an 83(b) filing. Please read the disclaimers and consult with your own tax advisors.
  • Does the service provider who is issued Restricted Stock (with repurchase rights) have to pay anything for the stock? Can the original founder pay for the Restricted Stock and give the stock at no cost to the other founders?
  • @Ted - If the service provider doesn't pay FMV for the stock, then the service provider would be taxed on the value of stock received. Founders can gift stock to other founders, but subject to gift tax rules.
  • Joe Smeagle
    I received stock options. Then I purchased those options and filed a 83b election. The stock was converted to a marketable stock when the company was purchased by a public company. I sold some of the stock this year. The basis for the stock is the price I purchased it for? The 83b did what?
  • @Joe - please read the article again. If the options were early exercised, then the 83(b) election avoided you being taxed as the shares vest. Your basis in the stock is what you paid for it. Please read the disclaimers and consult with your own tax advisors.
  • Ben
    Great site.
    Can 83b elections be used with an LLC or are they solely for C corps?
  • @Ben - yes, they can be used for LLCs. Please check with your own tax advisors.
  • CJ
    What if you filed the election within 30 days but forgot to attach a copy to your return?
  • @CJ - you should ask your tax preparer. I would guess that a lot of people forget to file 83(b)s with their tax return.
  • ngk
    Thanks for this really useful post and responses! I have slightly different situation... I'm a founder, but waiting for authorization to work legally. in the meantime other founders incorporate and sign the share and vesting agreements, and I'm 'granted' founder shares as well. Since my share/vesting agreement is conditional to being an employee, would my 30 day window start from my join date, or would it be the date the general share agreement was signed? Hope you can respond, thanks!
  • @ngk - 30 days starts from when shares are issued, meaning the date an agreement is signed and check received by the company.
  • Ed
    What if the Stock Certificate was never physically issued? Agreement signed, check cashed, but no stock certificate, does that still trigger the 30 day period?
  • @Ed - Stock is issued when agt signed and check delivered. Physical delivery of certificate doesn't matter.
  • simon_button
    Hi Yokum, great post. I understand that an 83b is required when restricted stock has substantial risk of forfeiture. Assuming a startup has restricted stock, but the restrictions are based on only two aspects, 1) being death of founder, and 2) being breach of confidentiality and non-competition, then would this be considered a "substantial risk of forfeiture"?
  • @simon - you'll have to engage someone to research the question. I would guess that it probably isn't a substantial risk of forfeiture, but I'd probably file an 83(b) anyway.
  • smythe
    Yokum,

    Procedural question on 83(b) form...

    Is line 6 of 83b election form supposed to be the per share price at incorporation whatever it is established? (e.g. $.0001)?

    Is line 7 of 83b election form supposed to be the total cost of shares (i.e. $.0001 x # of shares) (e.g. $565)?

    Thanks...
  • @smythe

    line 6 - aggregate fair market value of the shares

    line 7 - aggregate purchase price of the shares

    Line 6 and line 7 should be the same number (except for unusual circumstances)
  • Adam Smith
    Excellent post. I do have a different but related question. I'm the co-founder of a startup. The co-founders' equity stake was arranged as a straightforward common stock purchase without a vesting clause, at a price of $0.0001 per share. Because there has been no vesting, my understanding is that 83(b) doesn't apply. However, within a month of the purchase, we raised our first round of serious funding from angel investors at a price of $0.50 per share. My question is: When do the co-founders start owing taxes on the $0.4999 per share of unrealized gains? Hopefully, these gains are treated as ordinary capital gains and the co-founders won't owe anything until the date they sell their shares.

    Another detail that might be relevant is that none of the cofounders were employees at the time when these contracts were executed happened. They were only on the board of directors.
  • @Adam - No need to file an 83(b). No tax event for founders upon angel financing. Tax event occurs when the shares are sold. Please check with your own advisers and read the disclaimers.
  • Lee_Andrew
    Yokum, I have read the disclaimers and i am in the process of getting a tax advisor. BTW, any tax advisor that you would recommend in the bay area?

    Last year when my company was started the 4 founders signed purchase agreements and filed 83b exemptions on time. After a few months of work, 2 founders decided to have a less active role in the company and move to consulting roles. This demanded a restructuring of the shares to better reflect past and future contributions. Now, i will be getting 2X the numbers of shares i reported in the 83b form through a new purchase agreement. The FMV of the shares is the same.
    So
    i) Should submit an amendment to the IRS?
    ii) where i would find an amendment form?
    iii) or should i just resubmit a new 83b for the additional new shares? I read somewhere that an 83b can only be filed once.
    iV) Should i push for a private letter ruling confirmation for the change in numbers of shares?
    v) should i discuss this with a CPA or a tax lawyer?

    Thanks for your support of the entrepreneurial community
    Delfi
  • @Andrew - please read the disclaimers and check with your own advisors.

    i. If the shares are subject to a repurchase option, then a new 83(b) should be filed with respect to the newly issued shares.

    v. yes
  • Mary
    Great artical! We are the founders (two of us) of new start up company and we signed the Common Stock Purchase Agreement with Repurchase Option six month ago. We were so busy and did not do anthing after we signed the Agreement. We did not file the 83(b) either. Both of us did not actually pay to purchase the stock. Our questions are:
    1. do we have any tax issue?
    2. can we modify the Agreement?
    2. can we cancel the Agreement and start over again?
  • @Mary - if stock was actually issued to you, subject to a repurchase option/vesting, then you have a potentially serious problem if you haven't filed an 83(b) election. If the stock was never paid for, then you may be able to take the position that there was never any stock issued and the 83(b) election is not late. Please read the disclaimers and consult with your own advisors.
  • Arnold
    My understanding is that 83(b) does not apply if founders contributed property in return for stock. However to keep the founders together if the stock granted ALSO had a repurchase option at 110% of purchase price based on vesting schedule - does 83(b) apply? This agreement was done in 2003 so not sure what 83 (b) rules were then but no 83 (b) election was filed because council felt that contributed property in return for stock override the repurchase option clause. What are your thoughts?
  • @Arnold - I think you should have made an 83(b) election. It doesn't matter if the stock was purchased for cash or contribution of property. If the stock is subject to vesting, then it is likely that it may be considered in connection with services and Section 83 of the Internal Revenue Code applies. Please read the disclaimers and consult with your own advisors.
  • michelle8
    In your example above, assume the FMV is $.33 and they file an 83b election. What do they report on the 83b election? $.33 cents or $.01.

    How does it get reported on the employees tax return? Through the employer including it in the employees W2 or does the employee pick it up as other income on the 1040?
  • @michelle8 - Not sure what example you are talking about, but you would report it like the following:

    6. The fair market value at the time of transfer, determined without regard to any restriction other than a restriction which by its terms will never lapse, of such property is: $0.33

    7. The amount, if any, paid for such property: $0.01.

    Defer to accountants on how it is reported.
  • danconner
    If a founder's stock is purchased free of vesting but investors later impose vesting on the stock subject to a Vesting Agreement, does an 83(b) election need to be made?
  • @danconner - No.
  • sue
    Has anyone assigned a value of $0 for the 83b election or isit nedessary to assign say .01 cent
  • @sue - You could assign a value of $0 if you didn't pay for the shares and received them for free.
  • Yokum:

    Thanks for your extremely helpful posts. We have an LLC with my wife and I as founders. We've brought on a third co-founder and would like to issue additional shares to offer to him. Would the 83b election details you describe above be relevant to our situation, or are they only relevant to S- and C-Corporations?

    --Dean Richardson
  • @Dean - It depends on the type of LLC interest. If it is subject to vesting (i.e. a repurchase right), then yes. Please consult with your own attorney.
  • Greg
    Yokum - tremendously helpful insight in your post and replies. Thank you. I have one, perhaps basic question: if I made an 83b election in Dec '06 and the FMV and price paid were the same ($.01/share), and then I sold the stock in a transaction where a 3d party purchased (company did not exercise its right of first refusal and allowed the transaction to go through) my founders shares in Jan '08, do I owe simply owe the difference in b/w FMV and stock paid per share as long-term capital gains when I'm filing my '08 taxes now? Thank you in advance.
  • @Greg - please check with tax advisors. If your basis is original purchase price, then your gain = sale price - original purchase price. LTCG applies if held for more than a year.
  • david siewers
    ok, so a person has purchased restricted stock with 4 year vesting, and he has filed the 83b. He leaves after two years, and 50% of the shares are "repurchased" (really cancelled). Can the person take a loss on the stock not vested for which he paid for? How is that handled for tax purposes? anybody know?
  • @David - please check with tax advisors. In a typical repurchase, the repurchase price is the same as the purchase price, so there is no gain or loss, so no tax effect. In addition, in a typical purchase of restricted stock, there is no delta between FMV and purchase price at the time of purchase, so there is a no tax by making the 83(b) filing in that situation.
  • adam
    I am involved in a startup LLC that has 4 members. 2 'founders' that are not having their shares vest and then 2 other people they hired that will have shares vesting over a couple of years. There will only be one class of common shares. Two questions. 1) Does the company actually have to issue shares and if so, when? 2) Does this mean only the 2 of us that don't have vested shares have to file an 83(b) election?
  • Yokum, you have an amazing resource of a lot of value for entrepreneurs. Also thank you for taking the time to respond to these type of inquiries.
    I know that (missing) an 83b election is one of those things that can cause a lot of issues for the founders down the line. My fresh company just formed a C-Corp in Delaware - 10M shares @ $0.0001 as per your recommendation.

    We don't want to bother with issuance of founders stock nor stock restriction agreenment right now. Down the line we will have take care of the legal items when we have time and resources to address that.
    We plan to impose vesting restrictions on all the founders including myself.

    So my question is this: Can we simply not issue the stock now and really address this at a later time retroactively. It's my understanding that the company can continue to function without allocated shares, with me being the sole director. Thus I will have to do the 83b election at the allocation time-frame, or am I making a mistake by not taking care of these legal things now?
    Thank you so much!
  • @Ilya - If there is more than one founder, then failing to issue founders stock at the beginning may lead to arguments about who was promised what later. Not taking care of things properly in the beginning will be a hassle to fix later, which will results in significantly increased legal costs.
  • snj
    What are the rules around a restricted stock purchase agreement that has no vesting. Does it require an 83(b) filing? Does the owner of the stock required to recognize it as income as the stock gains value over time.
  • @snj - If there is no repurchase right (vesting), then there is no tax impact until the eventual sale of the stock.
  • JS
    Hi Yokum,

    I have just become an employee of a small private startup company and I will be getting restricted founders stock that vests over 3 years as compensation for service. The company has helped me fill out my 83b, but I'm not sure if the FMV that I'm told to use is correct.

    I am told to use the price that I paid for my shares as the FMV because there is no real FMV for my shares. My price was based on $0.001/share. But, I know that there were investors that have purchased non-vesting shares before I joined for $1/share.

    Would the purchase price for my founders shares be the FMV even if investors have paid a different amount per share? Do I need something from the company that states what the FMV is for my shares to back up my 83b claim to the IRS? If so, what kind of document would that be and how would the company calculate the FMV since there is no real value yet?
  • @JS - If the investor purchased common stock, then there probably is an issue. If the investors purchased preferred stock and you purchased common stock, then there might be a rationale for the price distinction. Common stock is typically valued at 25% to 30% of the preferred stock price for early stage companies, so the $0.001/share may be suspect. However, there are many examples of issuances of common stock at nominal prices simultaneously with a venture financing, and I have not heard of the IRS challenging a price difference on an audit. With 409A regulations and the IRS looking more carefully at common stock valuations, there is probably more risk these days. It would make sense to discuss this with the company's outside counsel.
  • jwootton
    Yokum, Great post. In preparation to incorporate a startup as a sole shareholder, I was planning to immediately upon filing the articles, first purchase for cash at 10 cents per share 100% of my new corporation's common stock, file the 83(b) within 30 days, followed later by a contribution of a personal service agreement worth a very large fair market value; so as to avoid incurring a large tax on receiving the stock if it had been exchanged for the personal service agreement at the outset. There would be no restrictions or forfeiture provisions. I understand about needing counsel before executing; but could this conceivably work to avoid the large tax on the large valuation of the company and its stock after the contribution of the personal service agreement? Thanks again for your excellent post.
    Jim
  • @jwootton - I don't understand the question. If the stock is not subject to a substantial risk of forfeiture, then your question really has nothing to do with 83(b). I think you probably should probably study Section 351 of the Internal Revenue Code, which generally provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control of the corporation. You seem to be assuming that there is necessarily a taxable event involved in contributing property for stock. Please read the disclaimers and consult with your own advisors.
  • Kent Mannenbaum
    Mega-dittos Yokum...

    Q #1: I am startup founder & will soon purchase 10,000,000 founder shares @ $0.001 for which I will be paying $10,000. The shares vest over next 4 years. I file the 83(b) now because I don't want to owe any tax on the monthly vesting shares that (I pray) will be increasing in value over the next 48 months. Correct so far?

    Q #2: The 83(b) that I file only covers my founder shares -- it is not an overall 83(b) filing for the company's shares?

    Q #3: Any subsequent 83(b) filings should be done by any future employees whose stock vests over time? I can see how a hypothetical employee who is not very organized might be extremely unhappy with future tax consequences if they receive stock that vests and were advised to file the 83(b) and forgot to do it...? Can this problem come back to bite our company's derriere? (we can't file the 83(b) for the employee can we?

    Q #4: If the company brings in/hires several "advisors" and pays them a token $100 plus 10,000 shares... Do I have to establish an FMV for these shares each time I bring in/hire each advisor? And, if the advisor shares have no vesting provision there's no need for an 83(b) filing for each advisor, is there?

    Q #5: Re: Compensation for Advisors... Is it the more common practice to
    a) give shares outright?
    b) sell shares outright at a deep discount?
    c) give an option to buy the shares?

    THANK YOU YOKUM!!!
  • @Kent,

    Please read the disclaimers and talk to your own advisors.

    1. Correct.

    2. Correct.

    3. If someone purchases stock at FMV subject to a repurchase right, it is a no brainer to file an 83(b) election as there is no taxable spread between purchase price and FMV. If the person forgets to file an 83(b) election, there there is the potential for a serious problem. Companies (and law firms) generally do not like to take the liability associated with being responsible for filing 83(b) election in the event that the IRS never receives the form or it is filed incorrectly. In the event that an 83(b) election is not filed and the the stock appreciates in value as it vests, the company is required to pay the employer’s share of FICA tax on the income and to withhold federal, state and local income tax.

    4. Receiving stock for services results in taxable income equal to the FMV of the stock received, so there needs to be a determination of FMV in order to determine the amount of income received. If there is no repurchase right that lapses over time tied to continued services, then Section 83(b) does not apply.

    5. Items a and b result in immediate tax to the advisor, so an option to purchase common stock at FMV on the date of grant is the most common way to compensate advisors. Some advisors may wish to early exercise NSOs when there is no difference between the exercise price and FMV in order to start the capital gain holding period.
  • John G.
    What if the 83b got filled in and filed incorrectly? Specifically, what if there was a mistake in the fair market value. What is the process to amend an 83b form?
  • @John G. - While it is theoretically possible to amend a form 83(b), it is very difficult to to revoke or rescind an 83(b) election. Without researching the subject, I suspect that one would file an amendment in the same matter as the original filing, but I'm not sure as I would defer to tax specialists. When the numbers are large, one might consider getting a private letter ruling from the IRS. As a practical matter, you will need to engage tax advisors or the mechanics of filing an amendment. Whoever is responsible for filing/defending your tax return will need to be comfortable on the mechanics. As always, please see the disclaimers and consult with your own tax advisors.
  • NY
    Much of this discussion presumes that stock is being purchased directly at FMV and thus there is no taxable income associated with the purchase. However, it is usually the case in a startup company that employees will be given stock options with an exercise price that - if the business is a success - should be below the actual value of the stock once they exercise the option. In that case, there is taxable income, but the FMV could be difficult to determine if the company is not publicly traded. How can you exercise an 83(b) if you can't determine (without an accountant) the spread between the option strike price and the value of the stock?

    Also, you mention that that "income is recognized as the repurchase right lapses", but what if other restrictions remain, e.g. restrictions on transference? Would that also prevent the realization of income?

    Also, what if the repurchase right is perpetual and never lapses because no date has been set for it to lapse? Is it possible to convert that stock to stock not subject to repurchase?
  • @NY - as always, please read the disclaimer and consult with your own tax advisors.

    First, some technical clarification. An 83(b) election can be filed when stock is purchased in connection with the performance of services and the stock is subject to a substantial risk of forfeiture. An 83(b) election with respect to the receipt of an NSO is void because an 83(b) election may only be made with respect to property that has been transferred. NSOs, without a readily ascertainable fair market value, are not property subject to Section 83. Most NSOs do not have a readily ascertainable fair market value, and thus, an 83(b) election cannot be made with respect to those options. In addition, an 83(b) election is not effective with respect to stock transferred on exercise of an ISO (although the election may be effective for AMT purposes).

    In a situation where a person wants to file an 83(b) election with regard to early exercised options, the individual should ask the company what the current FMV of the common stock is. Most venture-backed companies continually grant options, so the board has determined what FMV is at the time of each option grant (and often have 409A valuation reports to back up the FMV determination). In the absence of a recent option grant and determination of FMV by the board, I suspect that using the last option grant price/FMV would be a fair benchmark.

    A typical transfer restriction, such as a right of first refusal on transfer in favor of the company until an IPO, is not something that results in a substantial risk of forfeiture. The issue is whether there is a substantial risk of forfeiture.

    If you are really interested in reading about what transfer restrictions prevent stock from being substantially vested for purposes of Section 83, please feel free to read IRS Revenue Ruling 2005-48.

    Finally, transfer restrictions are contractual and can typically be amended with the agreement of the parties.
  • AnotherSteve
    Much of this discussion presumes that stock is being purchased directly at FMV and thus there is no taxable income associated with the purchase. However, it is usually the case in a startup company that employees will be given stock options with an exercise price that - if the business is a success - should be below the actual value of the stock once they exercise the option. In that case, there is taxable income, but the FMV could be difficult to determine if the company is not publicly traded. How can you exercise an 83(b) if you can't determine (without an accountant) the spread between the option strike price and the value of the stock?

    Also, you mention that that "income is recognized as the repurchase right lapses", but what if other restrictions remain, e.g. restrictions on transference? Would that also prevent the realization of income?

    Also, what if the repurchase right is perpetual and never lapses because no date has been set for it to lapse? Is it possible to convert that stock to stock not subject to repurchase?
  • AnotherSteve
    Much of this discussion presumes that stock is being purchased directly at FMV and thus there is no taxable income associated with the purchase. However, it is usually the case in a startup company that employees will be given stock options with an exercise price that - if the business is a success - should be below the actual value of the stock once they exercise the option. In that case, there is taxable income, but the FMV could be difficult to determine if the company is not publicly traded. How can you exercise an 83(b) if you can't determine (without an accountant) the spread between the option strike price and the value of the stock?

    Also, you mention that "income is recognized as the repurchase right lapses", but what if the repurchase right never lapses? What if there is a contract that allows for repeated call options until all granted stock has been repurchased at a mutually agreed-upon FMV (possibly with the assistance of an outside appraiser or accountant)? Would income then be recognized at the consummation of the call option (i.e. when the stock is actually paid for by the caller)?

    Also, do you know in such a circumstance if it is possible to convert such stock to fully vested stock, i.e. no longer subject to call options? Does that need to be built into the initial contract?
  • @Mike - Please check with tax specialists or tax advisers and read the disclaimers. I believe that this is characterized as a repurchase by the company of the stock and sale to the CEO. I think an 83(b) filing probably should be made, especially if FMV and the purchase price are the same.
  • Mike
    I am helping a company where the newly hired CEO is buying shares from a founder (i.e. they are shares owned outright by another employee), but they are subject to a repurchase right that lapses over a service period. Can the CEO file an 83b even though the shares are not sold to him by the employer?
  • @Tony - I don't understand the question. Typically, if you make an 83(b) election, no tax is paid as there is no difference between purchase price and FMV. Even if the stock is later repurchased by the company, there is no tax paid unnecessarily. If you fail to file an 83(b), income is recognized as the repurchase right lapses, so there is no payment of taxes that needs to be credited back with regard to repurchased stock. I suspect you are envisioning a situation where stock is issued at a discount to FMV, tax is paid on the discount element, then the stock is later repurchased. Please read the disclaimers and consult with your own tax advisers.
  • @Bill - That question has already been asked and answered. No 83(b) filing is necessary unless the option is exercised and subject to a right of repurchase. Please read the disclaimers and consult with your own tax advisers.
  • I am a bit confused on the failure to satisfy restrictions risk. You mention that forfeiture of the unvested stock would occur, but you also mention that we would not be entitled to a refund of taxes paid. Are you only talking about the FICA portion of taxes paid? I would assume that any Fed/State withholdings would still be on the W-2 and subject to recapture upon filing at year end. Would the FICA tax paid be a capital loss (subject to capital loss limitation rules)?
  • Bill
    I am about to sign an employment contract in which I will receive a salary and a certain number of stock options at a price equivalent to current FMV vesting over a three-year period. Should I assume from Yokum's post of August 23rd that there is no need for the election at this point?
  • @Matt - no, but it should be attached to your federal return for the year that you made the election. Please read the disclaimers and consult with your own tax advisers.
  • Matt
    I am filing an 83(b) election right now with the IRS. Do I also need to file one with the state of California, where I live?
  • @Gadha - you need to consult with a tax advisor.
  • Gadha
    I purchased unvested stock 3 years back, and I'm sure I filed a 83b. But I never kept a copy and did not send a copy it along with my federal tax returns. Is that a problem? Should I do something about it?
  • James
    Thanks Yokum, my counsel and CPA concur... your thoughts are reassuring.
  • @Sunny - no. Please read the disclaimers and consult with your own tax adviser.
  • Sunny Kalid
    Thank you for your reply. Now, I have a simple question. I spent $0.1 for unvested shares this year. The FMV is also $0.1. I made 83b election. Because the difference between the purchase price and FMV is zero, should I pay any tax for this tax year (property transfer)?
  • @James,

    You should ask this question of company counsel and your personal tax adviser. Do not rely upon this blog for personal tax advice.

    Generally speaking, if you are entering into a stock restriction agreement after the initial issuance of stock and the stock was not originally subject to a repurchase right linked to continued employment, then you do not have to file an 83(b). Many people do it anyway for prophylactic purposes and plug in the original purchase price on the form.
  • James
    I founded a company two years ago and was issued 10,000 shares at $0.01 per share. To close a Series A financing, I am required to sign a Stock Restriction Agreement that provides for four-year vesting of 3/4 of my shares. The provisions of the SRA provide for the stock to be repurchase at the lesser of FMV (currently $0.25) or $0.02.

    Is an 83(b) election needed in this case? If so, would the FMV be $0.25 or $0.02? Would I be recognizing income in this situation?
  • @Sunny,

    1. Generally yes. Read paragraph 4 of the post.

    2. Read paragraphs 5 and 6 of the post.

    3. Assuming that some of the shares were fully vested upon purchase and the purchase price was FMV, then the potentially fatal tax consequences described above will not apply. Read the post for the tax impact as the unvested stock vests.

    Given your questions, you should consult with a tax adviser.
  • Sunny Kalid
    I am working in a startup company. I bought some amount of unvested stocks (FMV and the purchase price are the same).
    Question 1: Should I make 83b election?
    Question 2: If I did not make 83b, what will happen to me? Doed it affect my tax when selling?
    Question 3: What is difference between the vested stocks I bought and the unvested stocks I paid (if no 83b election was made)?
  • @John - Only if stock is actually issued in connection with services and is subject to vesting/repurchase.
  • John
    Does 83(b) election apply to options and warrants?
  • @Mike - June 25, the date of the award.
  • Mike
    My company periodically grants awards of restricted stock. The restricted stock agreemement notes that shares of restricted stock are awarded on June 25th. The restricted period also begins June 25th. My company notifys us of the award and delivers the agreements to us on July 28th. When does my 30 day 83(b) election window begin? At the agreement "award" date of June 25th or the date I actually received the notice of award and the paperwork, July 28th?
  • @Rocky,

    If the stock is subject to repurchase, then the founder should file the 83(b) to accelerate the recognition of income as the repurchase option is released. A repurchase option that lapses subject to continued employment is evidence that the stock is issued in connection with services, which triggers Section 83 of the IRS Code.

    The difference between a stock grant and a sale of the stock is simply the amount of tax recognized at the time of stock issuance. A stock grant results in taxable income upon grant equal to the difference between FMV and zero. A sale of stock results in zero taxable income at issuance if FMV and the purchase price are the same.

    While the repurchase price of the stock is typically the (nominal) price paid by the founder, it can be any price set by contract, regardless of the actually price paid by the founder.
  • Rocky
    In the scenario described, the founder paid $0.01/share (FMV) when receiving the restricted stock. What would his/her 83(b) election be for? He hasn't received any income--he paid for the stock.

    I'm trying to understand the tax and legal differences between stock grants (where employee doesn't pay for it) and stock sales (where he pays the FMV). Advice/pointers would be appreciated.

    Also, if stock is granted (not paid for), how is it recovered if the employee leaves before vesting...it can't be repurchased--it was never paid for in the first place. Any legal/tax issues here you can explain or provide pointers to? In this Palm Inc. stock grant, the company loaned the employee cash to purchase the shares. Was this likely arranged to provide a way to recover/repurchase the shares?
    http://contracts.corporate.findlaw.com/agreemen...
  • @Jim - Generally, the stock is not "issued" until it is paid for. You do not need to file the 83(b) until the stock is "issued." I don't understand what you mean by "filed." You need to work with an attorney and a tax adviser to sort this out. Depending on the exact facts, I suspect that you take the position that the stock was (i) never issued, or (ii) was issued but not subject to any repurchase rights.
  • Jim
    Thanks for a great article. What if the stock is issued but not filed until a year later and it is also not "purchased"? So basically, I didn't pay for the stock but an agreement was executed over 1 year ago and the company is filing the documents now. Is it too late to file the 83(b)? or because it was never purchased by me (no money was exchanged and no agreement for paying for the stock was executed or discussed), is the agreement void? Or am I liable for taxes on the new value of the stock? Or can I send the company a check and file the 2007 83(b) with a copy of the check? I also have not yet filed 2007 taxes. Not sure if this helps my case. I know this is a complete mess........
  • @Steve. Yes.
  • Steve
    Great article. Here's a nuanced question. We're a small company performing services for the startup and will be granted this type of founder's share with vesting over time. Are we eligible for same 83(b) election as would an employee of the company?
  • The trigger for filing an 83(b) election is the purchase of shares subject to a substantial risk of forfeiture. Incorporation by itself does not trigger the need to file an 83(b) election.
  • C Spring
    Suppose I incorporated Company XYZ, Inc. Do I file Election 83(b) at incorporation or when I sign a stock purchase agreement with Company XYZ, Inc. When I form the company, I may assign the share ownership but may not technically own the shares unless a stock purchase agreement is signed. Is that right?
  • Unvested founders stock is typically subject to repurchase upon death of a founder. Repurchase upon divorce is unusual.
  • CH4
    As founders of a start-up company, my husband and I were presented with a restricted stock purchase agreement that contains death and divorce clauses. Basically, if he dies or we get divorced before the stock is totally vested, any stock that is awarded to the spouse will be subject to repurchase by the company. I have not seen these clauses in other example documents (I would like them removed). Is it customary to include these clauses?
  • Section 83(b) is only applicable to property transferred in connection with the performance of services. It is not a mechanism to pre-pay taxes in connection with an investment.
  • Nimo
    Great post! Is 83(b) only applicable to employees? I wanted to invest in a friend's company and wanted to see if I can pay taxes on my investment ahead. I understand I might lose both my investment and taxes paid if the company goes bankrupt, but in the event of a successful exit, I would have saved money in taxes should I paid it on the lower valuation. Is it possible as an investor to take advantage of 83(b)?
  • Not sure what the question is. Typically, founders stock is issued pursuant to a restricted stock purchase agreement that has a right of repurchase in favor of the company that lapses over time as the stock vests. If the founders stock is initially issued pursuant to a stock purchase agreement without a right of repurchase, the founder would enter into a stock restriction agreement in order to implement the repurchase right. This typically occurs in connection with a financing when the investors insist that the founders stock be subject to vesting.
  • This is a great post. We are going through this right now. My attny's are suggesting that we have a stock purchase agreement and a stock grant agreement. Can the same thing be accomplished through a stock purchase and vesting agreement? Are there different tax consequences.
  • Brilliant post - this is a MUST read for every entrepreneur.
blog comments powered by Disqus