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Understanding the 83(b) Election: Its Importance and Implications

By May 6, 2024No Comments

Note: The following information is relevant only for U.S. taxpayers. You should consult with a personal tax advisor about whether an 83(b) election is appropriate for your own tax situation.

The 83(b) election is a U.S. federal tax filing commonly utilized by startup founders and early employees when they acquire stock subject to a vesting schedule. Filing an 83(b) election with the Internal Revenue Service (IRS) allows a stockholder to pay all income taxes on their shares in the year of acquisition, based on a presumably low fair market value of the shares, rather than as the shares vest over time, based on a presumably higher fair market value at the time of vesting. Electing to pay this tax once upfront usually results in savings. However, the 83(b) election may not be advantageous in all situations, such as when the fair market value of the shares is likely to decline from the purchase date. Unfortunately, a stockholder cannot adopt a wait-and-see approach with the 83(b) election. It must be filed within 30 calendar days after the purchase or transfer date to be effective, and it cannot be submitted online.

The 83(b) election is applicable when acquiring actual shares of stock subject to vesting. You don’t need to consider an 83(b) election when receiving a stock option, even if the option is subject to vesting, unless the option is “early exercised” (i.e., the underlying stock option shares are purchased while they are still subject to vesting). 83(b) elections are also generally not applicable to restricted stock units (RSUs), which are different from the shares of restricted stock that startup founders and early employees typically deal with.

Don’t procrastinate on the 83(b) election. Filing an 83(b) election requires mailing it to the IRS, and the postmark date determines if your filing was on time. If you’re acquiring stock that is subject to vesting, complete the 83(b) election paperwork and mail it to the IRS as soon as possible to avoid a last-minute rush to the post office.

Keeping proof of a timely 83(b) election filing is vital. Send the 83(b) election via certified mail, select the option for “return receipt requested,” and include an extra copy of the completed 83(b) election form along with a self-addressed stamped envelope. The IRS will mark the copy as “received” and return it to you. Once you receive it, keep this IRS-stamped copy and share the proof of filing with the company that sold or granted you the shares.

Consider keeping additional evidence of filing, like photographs of the completed 83(b) election form and mailing envelope, screenshots of any tracking history, and the certified mail return receipt. These can be useful as proof of filing if the IRS doesn’t return a stamped copy or if the mail gets lost or delayed.

Startup investors and acquirers are keenly aware of, and aim to avoid, the potential personal and business consequences of missed 83(b) elections. These consequences can include unexpectedly high taxes for founders and penalties for companies that fail to withhold employee income taxes on vesting shares. Lawyers representing these parties will require proof of timely 83(b) elections from anyone who has acquired startup stock subject to vesting. Missing 83(b) elections can lead to lower financing valuations, decreased acquisition prices, increased indemnities, deal delays, and higher transaction costs due to the legal effort needed to address 83(b) election issues. There is no perfect remedy for a missed 83(b) election filing.

Filing an 83(b) election on time and maintaining good records of the filing will save you and your company time, money, and hassle.

Author Foley Ignite

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