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.

Comments

  • 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.

  • 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

  • Chad

    What if I e-File? How do I attach the form?

  • 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?

  • http://www.startupcompanylawyer.com Yokum

    @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.

  • http://www.startupcompanylawyer.com Yokum

    @KT – I punt to tax advisors.

  • http://www.startupcompanylawyer.com Yokum

    @Jane – please consult with a tax advisor. You will need some documentation from the company that the common stock was rendered worthless.

  • 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

  • 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

  • http://www.startupcompanylawyer.com Yokum

    @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.

  • http://www.startupcompanylawyer.com Yokum

    @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

    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,

  • Dennes

    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!

  • http://www.startupcompanylawyer.com Yokum

    @Guest – you should ask a tax preparer.

  • http://www.startupcompanylawyer.com Yokum

    @Darryl – Tax on exercise of an option depends on whether it was an NSO or an ISO — not whether you file an 83(b), which affects the timing of the measurement of tax. Early exercising an option may make sense if the aggregate exercise price is low.

  • hopenottoolate

    Question:

    I was awarded the Restricted Stock Option last year (Jan 2009) but didn't take any action. Now if I purchase the stocks, can I still make the 83(b) election? Or this can only be done within 30 days of awarding of the options?

    Thanks

  • http://www.startupcompanylawyer.com Yokum

    @hope – you can make an 83(b) within 30 days of the purchase of the stock (i.e. early exercise of the option) if the shares are subject to a repurchase option.

  • gedleb

    What if one of the partners units are not restricted (but the others are)? Can the partner with unrestricted units also file an 83 B ?

  • leo_wang

    Yokum, thanks so much for your post! I made the selection middle of last year but forgot whether I mailed it to IRS or not. Is there a way to find this out? Can I attach a copy with this year's return to fix the potential problem of not mailing?

  • http://jeremyricketts.com Jeremy Ricketts

    So, about 6 months ago, I joined a startup and sent in my vesting schedule to the IRS. The 83(b) was mailed within a few weeks.

    4 months go by and I decide, for the heck of it, to call the IRS and make sure they have the document on file. 5 IRS agents and 54 minutes later… I finally get a hold of someone who even knows what a 83(b) is. They proceed to tell me that they don't keep that on file. She suggested that I mail a copy in with my personal return.

    If they don't keep it on file and it's not a part of my personal tax record… why are we even sending these in? Do people really have problems when they fail to send in a form that the IRS doesn't appear to even track?

  • Richard Braithwaite

    Let's assume I do the 83(b) election this month when I form the C-corp.
    If, in 6 months, the company brings in an additional “founding partner,” will it be necessary for the new co-founder to do their own 83(b) election?

  • BRDixon

    I have an employee who made an 83b election and we are paying her dividends.

    The restricted stock vests over a three year period.

    Should I also issue her a stock certificate with a specific ledger stating the vesting period.

  • Greg

    I filed my 83b election a few days ago, but I did not mail it certified mail. Can/should I mail another election certified to ensure the IRS receives it?

  • http://www.startupcompanylawyer.com Yokum

    @Greg – I might if you are still within the 30 day period and you did not include an extra copy with a request to return a file stamped copy in a self-addressed stamped envelope.

  • Sjforest

    I am working for a start up and am going to receive a % of ownership in lieu of a salary for the first year. Do I need to make this election?

  • Atapres

    To attract key employees, we would like to issue restricted shares subject to a repurchase agreement. Does it matter if they earn them by receiving lower salary or better to be purchased directly? We believe that because of the substanial risk and restriction, they would not have currently taxable income. At the end of the restriction period, will they be taxed on value at original issuance or the FMV? Should they file an 83b when the RSU is issued or after the restriction period ends? We are trying to maximize capital gain and minimize ordinary income.

  • http://www.myStockOptions.com Bruce

    Beyond the founder situation, it's important for employees to know that when they exercise options that turn into restricted stock and make the Section 83(b) election, any taxes paid are not recovered if the shares never vest. Also not all employee stock options in pre-IPO companies are structured this way. In most grants, the options need to vest first before they can be exercised. These options result in stock that does not need to vest first and thus no 83(b) election.

    For more on these type of early exercise stock options, see the Pre-IPO section on http://www.myStockOptions.com. Section 83(b) is also discussed in the restricted stock part of that site.

  • Guest

    I have to file an 83b election form/letter. I understand that I should fill it out, etc. Should my spouse fill out a separate 83b election form/letter and turn it in separately to the IRS? I have been reading that the spouse needs sign or file as well.

  • http://rafaelcorrales.blogspot.com Rafael Corrales

    Excellent post!

    I'm curious… is there a Canadian equivalent of an 83b election? Let's say an employee in Canada has stock for a US company, would they just file the US 83b election or would they need to file something else in Canada as well?

  • http://www.facebook.com/erickarndt Erick Arndt

    I assume this is only for C-corps, right? There is no 83b election in LLCs. If I convert to the C-corp then I can make that election. Does that start the clock ticking all over again cap gains on my stock?

  • Guest

    Can you clarify the requirement that 83(b) only applies to property transferred in connection with the performance of services? Does this apply only to employees/consultants, or do founders need to document the transaction to reflect performance of services as consideration for the purchase of stock? Thanks.

  • Pete

    This post has been very helpful, but I have a question that I don't believe has been answered. I just joined a startup as a founding member, but on 10/1/2010 I signed an operating agreement that is effective 1/1/2010 (9 months prior). Included in the operating agreement is each founding member's “Member Interest” (percent ownership), but we will not receive certificates until January 2011. The Member Interest was not purchased with cash, it was earned through unpaid hours worked for the company (sweat equity).

    Can I file an 83(b) election in this situation?

  • http://www.startupcompanylawyer.com Yokum

    @Pete – it doesn't seem like the interests are subject to vesting (risk of forfeiture), so no 83(b) election is required. However, one can't tell without reviewing all of the documents.

  • http://www.startupcompanylawyer.com Yokum

    @Guest – stock subject to vesting is typically structured as a repurchase right that lapse based on continued services. Founder stock vesting is typically based on continued services. Don't understand the question.

  • http://www.startupcompanylawyer.com Yokum

    @Rafael – don't know.

  • Pete

    Thank you for your reply, Yokum. There is vesting for the Member Interest. Here is some supporting text from the company's operating agreement: “Membership Interests shall vest over a 3-year vesting period commencing from the date the Membership Interest is issued with 1/3 of such interest being vested after one year and the balance vesting quarterly over the next two years on a pro rata basis. In the event the holder of Membership Interests is not or ceases to be an employee or independent contractor, voluntarily or involuntarily, all Membership Interests which have not vested on or before the date of such determination shall immediately terminate and have no value whatsoever. Any Membership Interests which have vested on the date of such determination may be repurchased at the option of the Company at any time after the date of such determination…”

    Based on the above, should I file the 83(b) election? Also, when is the Membership Interest legally “issued” in my situation? Is it 1/1/10, the effective date of the Operating Agreement; 10/1/10, the date I signed the Agreement; or sometime in January 2011 when I receive a physical certificate? Thanks again in advance.

  • http://www.startupcompanylawyer.com Yokum

    @Pete – you should consult with an attorney with regard to your specific facts. I would file an 83(b). I suspect that the 30 days would have started from 10/1/10, although there is some argument that perhaps the interest was granted on 1/1/10, then later subject to vesting on 10/1/10. Hard to tell without all of the facts.

  • Luvmykids

    My husband wants me to sign the spousal consent part of the restricted stock purchase agreement. I don't understand what exactly I'm signing away. What happens if we divorce? Does that mean he has complete control of the shares he bough and I waive my rights to 1/2 the shares? we live in a community property state and I'm a stay-at-home-mom. help.

  • Erin

    This is a very informative post. However I haven't been able to find an answer to my situation: I am not American, and I live/work outside the US, but have received shares in a US-based startup company that I am working for. I have been told by the company to file the 83(b) election form. They seem to think that I need to. But do I really? It seems weird filing a form to the IRS when I have no US address and no taxpayer number.

  • cindy

    Great post!

    I have a question: I mailed the 83(b) within 30 days by certified mail, with a self-addressed stamped envelope. I checked USPS website with the tracking number and it showed that it was delivered. But three months passed and I haven't got the acknowledgement receipt from IRS. Is there a problem? How can I check if the IRS got my form on file? Is the certified mail record good enough?

  • Gary

    Yokum – we formed a new LLC and the founders have units that vest as follows: 1/3 immediately, 1/3 upon the closing of the seed financing and 1/3 upon closing of the Series A financing, provided that the founder continues to be “substantially involved” with the venture at each milestone. Should we seek 83b treatment for the 2nd and 3rd traunches of equity as they are subject to forfeiture, based on company performance and tied to “substantial involvement”? Thanks.

  • foster

    Is it possible to undo a filed 83b? I filed one having been told each share was worth 1 cent. Our company has just had an independent valuation done and the shares have been valued at 20 times that. I no longer want to pay all the taxes upfront. Thanks.

  • Roger

    Yokum, in an extreme case, if I all my restricted stock purchased vested (four year passed), I did not have any knowledge of 83b election at all, means did not file, did not pay the tax between purchase price and FMV, even did not pay tax for the vested parts in past four years. Now, the part of stock were sold at a significant gain. What is the exactly the fatal tax consequence? pay tax at ordinary income rate on vested part each year, penalty and accumulated interests on each years gain, etc. Is that right? What the tax rate will be on the gain between the first year's value (first 1/4 vested part) and today's sell value? For example, 0.01 was the initial FMV and purchase price, 1.01 was the value of one year later, and today the sold price is 10. there are $9 gain for this 3 year's holding. What is the tax rate on this $9 gain, long term capital gain or ordinary income rate? Thanks.

  • MarMar

    if a person elects an 83b will the employee paid payroll tax still be taken at the time of original vesting or is the whole transaction deferred?

  • Best Taxmen

    What if the election is not attach to the tax return. Can it be attached to an amended return? Ron

  • ntreuter

    I read this in Do More Faster for the first time, and I'm glad because I would have never known otherwise.

  • Marko

    if you elected for 83b when you started the company and you raise money afterwards and have a new vesting schedule etc, do you need to do the 83b process again, or since you already own the shares it's not necessary?

  • rpatel76

    The 30 day window starts from the date you received the shares, and this date should definitely be in records. If you feel doubt that you will be able to complete it in this time, I would strongly suggest working with a tax preparer or (cheaper route) going through services like 83belection.com that will do it for you in just a matter of days.

  • http://www.bendlawoffice.com The Law Office of Doug Bend

    If you are looking for more information on 83(b) elections, I recently published a post on the topic:

    http://wp.me/p1ivVG-ao

    Thank you,
    Doug

  • Miguel de Vega

    Extremely interesting post! 

    I wonder if it applies to our situation. We are nonresident aliens who just incorporated in Delaware, and who are about to issue founder stock subject to vesting. I think (but I am not sure) that we (as founders) will NOT have to pay income tax in the U.S., but in our residence countries. In that case, it would not be necessary to make an 83(b) election, since we wouldn't even have to get an Individual Taxpayer Identificaiton Number (ITIN). Does this make any sense to you?