For founders and early-stage employees receiving equity as part of their compensation, understanding the 83(b) election is a critical step in managing taxes and maximizing financial benefits. This article provides an overview of what the 83(b) election is, why it matters, and how to make an informed decision about filing it.
What Is the 83(b) Election?
An 83(b) election is a provision in the Internal Revenue Code that allows individuals who receive equity subject to vesting to pay taxes on the total fair market value of the equity at the time of grant, rather than when the equity vests.
Without the election, you are taxed as the shares vest, based on their fair market value at each vesting date, which could result in significantly higher taxes if the value of the shares appreciates. By filing an 83(b) election, you freeze the tax calculation at the lower initial valuation, assuming the equity was granted when the company was still in its early stages.
The 30-Day Deadline: Act Fast or Lose Out
The most critical requirement of the 83(b) election is meeting the IRS’s strict 30-day filing deadline. The countdown begins on the date the equity is granted. If you miss this deadline, you lose the ability to make the election—and the consequences can be costly.
If you fail to file on time, the IRS will treat each vesting event as a taxable event. You will owe taxes at ordinary income rates on the fair market value (FMV) of the vested shares on each vesting date, which could lead to a significantly higher tax bill as the company’s valuation grows.
There is no easy way to correct a missed deadline, making it essential to prioritize filing your 83(b) election immediately after receiving the grant.
How to File an 83(b) Election
Filing an 83(b) election involves several steps. It’s important to follow these steps carefully to ensure compliance with IRS requirements:
1.Complete the IRS Form 83(b):
- Use the IRS Form 83(b) Election, which simplifies the filing process.
- Fill out the form with your name, address, Social Security number, and details about the equity grant, including the number of shares and their fair market value.
2. Prepare a Cover Letter (if desired):
- While the form itself is usually sufficient, many filers include a brief cover letter to explain their submission, though this is not mandatory. A sample cover letter is available here.
3. Mail the Form to the IRS:
- Send the completed form to the appropriate IRS address. You can find the correct address using this guide on where to file paper tax returns.
- Use certified mail or an equivalent service to ensure proof of delivery and keep a copy of the receipt for your records.
4. Provide a Copy to Your Employer:
- Under IRS rules, you must also provide a copy of the 83(b) election to your employer. This ensures they are aware of the election and can process it appropriately.
5. Keep a Copy for Your Records:
- Retain a copy of the completed 83(b) election form and proof of mailing for your personal files. These documents may be needed in the event of an audit or future tax questions.
Is the 83(b) Election Right for You?
For most founders and early employees receiving equity at a nominal value, the 83(b) election is a straightforward and beneficial way to minimize taxes and maximize potential gains. However, the decision depends on your specific circumstances, including the value of your equity grant, your financial situation, and your confidence in the company’s future.
Consulting with an experienced tax advisor or legal professional is strongly recommended to ensure you understand the implications of your decision and file your election correctly and on time.
How Our Firm Can Help
Our team has extensive experience advising founders and early-stage employees on equity compensation and tax strategies, including the 83(b) election. We can help you assess your options, prepare the necessary documentation, and navigate complex tax laws to ensure you make the most informed decision.
By understanding the 83(b) election and filing it promptly, you can take a proactive step toward securing long-term financial benefits while minimizing potential tax liabilities. Don’t let the opportunity slip away—act quickly and confidently to maximize the value of your equity grant.