Entrepreneurs and the Section 83(b) Election

Entrepreneurs need to be aware of the 83(b) election.  In simple terms, you are taxed on any equity compensation that you receive in the same way that you are taxed on your other income.  The IRS requires you to pay taxes on that equity compensation in the year that it is actually transferred to you.

Founders’ stock is often subject to incremental vesting over a number of years.  If the founder does nothing, she would incur tax liability for the value of the stock at the time it vests.  Assuming that the value of the stock price is rising over the course of the vesting schedule, the value of the stock at the time of vesting could continue to increase (or fluctuate) so that the founder pays more taxes over time.

Fortunately, the Internal Revenue Code created an attractive option for startup founders with Section 83(b) of the Internal Revenue Code.  The 83(b) election provides founders with the option to be taxed for the entire amount of stock that is subject to vesting at the present value.  By making an 83(b) election, you pay tax when you receive the stock, but not when it vests.  Regardless of whether the election is made, you will also report capital gain or loss when you sell the stock. 

Do note –

  • If you have stock options, you do not need to file an 83(b) Election Form.
  • If you purchased/received founder’s stock and there are no restrictions, such as vesting, you do not need to file an 83(b) Election Form.
  • If you purchased/received restricted stock in a growing startup, you should consider filing an 83(b) Election Form.
  • The election makes sense if the price rises.  Remember that most start ups fail so you could end up overpaying tax.  Check out this Wall Street Journal article 

There is a sample election on the IRS site – http://www.irs.gov/irb/2012-28_IRB/ar12.html#d0e3012

Section 83(b) Election
The undersigned taxpayer hereby elects, pursuant to § 83(b) of the Internal Revenue Code of 1986, as amended, to include in gross income as compensation for services the excess (if any) of the fair market value of the shares described below over the amount paid for those shares.
1. The name, taxpayer identification number, address of the undersigned, and the taxable year for which this election is being made are:
TAXABLE YEAR: Calendar Year 20
2. The property which is the subject of this election isshares of common stock of .
3. The property was transferred to the undersigned on [DATE].
4. The property is subject to the following restrictions: [Describe applicable restrictions here.]
5. The fair market value of the property at the time of transfer (determined without regard to any restriction other than a nonlapse restriction as defined in § 1.83-3(h) of the Income Tax Regulations) is: $per share xshares = $.
6. For the property transferred, the undersigned paid $per share xshares = $.
7. The amount to include in gross income is $. [The result of the amount reported in Item 5 minus the amount reported in Item 6.]
The undersigned taxpayer will file this election with the Internal Revenue Service office with which taxpayer files his or her annual income tax return not later than 30 days after the date of transfer of the property. A copy of the election also will be furnished to the person for whom the services were performed. Additionally, the undersigned will include a copy of the election with his or her income tax return for the taxable year in which the property is transferred. The undersigned is the person performing the services in connection with which the property was transferred.