What is an 83(b) election? Should I file one?
An 83(b) election tells the IRS that you will be taxed on the value of granted shares today rather than recognizing income on their value as of the date that they vest. Because vesting can take a long time and your startup’s growth will hopefully increase the value of your shares, this can defer a significant amount of taxes until the date, if ever, that you sell your shares.
If you want to file an 83(b) election, you must postmark the form within 30 days of the stock grant date. It is best to send an 83(b) election by certified mail, and keep a record of sending it to the IRS. If you miss this window but would otherwise file an 83(b) election, you should consult your lawyer or tax advisor.
The actual difference an 83(b) election makes for you is that if your shares have a higher fair market value than the amount you pay for them, the difference is recognized as “taxable income”. If you pay the full fair market value of the shares when they are granted to you, the difference is zero so you do not have to pay any tax. However, if your shares vest over time, the IRS does not consider the grant to be final until the future dates on which the shares vest, at which time the fair market value may have gone up due to your company’s growth, resulting in tax obligations accruing on these future vesting dates. The 83(b) election is a choice to pay all the taxes now at their current amount (in other words, zero taxes), instead of paying in the future as shares vest (possibly non-zero).
Another consideration you should take into account is the tax you would eventually pay on the proceeds from selling the stock. If you eventually sell your stock (or otherwise receive money for your stock, for example, if your company is sold), your proceeds will be taxed as capital gains, which is at the lower “long-term” rate for stock held more than one year. Whether or not you file an 83(b), in both cases—taxation today or at vesting date—the stock grant is taxed as ordinary income tax, which is assessed at a higher rate than long-term capital gains tax. Capital gains tax is assessed on the gains you make in value between the point at which you are assessed income tax on the stock and the point at which you sell the stock. If you pay the higher income tax on the stock at a lower valuation (i.e. on its value today rather than the date of vesting), then the value increase taxed as capital gains will presumably be larger, but because this tax rate is lower, your actual tax burden will be lower overall than if more of the value was taxed as ordinary income (i.e. if you don’t file an 83(b) election and pay taxes on the fair-market value when the stock vests).
There are some circumstances in which an 83(b) is not advantageous. The above discussion is for educational purposes only, as we cannot offer tax advice or comment on your specific personal situation. Please consult a tax advisor for information and advice relevant to your unique circumstance.
Note: an 83(b) election only applies if you pay taxes in the United States, or expect to do so during your vesting period.