Who should make an 83(b) election filing?
Anyone who purchases or receives stock that is subject to vesting (for example, a founder or another service provider to a company, like an employee or advisor) should always consider making an 83(b) election filing. Although individual tax situations may vary and it is the responsibility of a taxpayer to decide whether any filing makes sense for their particular circumstances (and to obtain any independent, professional tax advice necessary to make such a decision), making an 83(b) election is almost always beneficial, while failing to make an 83(b) election could result in damaging and often unexpected tax consequences.
What does an 83(b) election do?
When a founder/service provider purchases or receives stock that is subject to vesting, the default tax treatment (found in Section 83 of the U.S. tax code) is that the founder/service provider will recognize income, each time the stock vests, equal to the difference between the amount paid for the stock and the fair market value of the stock at the time of vesting. If the stock has a standard vesting schedule of monthly vesting over four years with a one-year cliff, then this means the founder/service provider would recognize income 37 times: once at the one-year cliff and 36 more times as the stock vests monthly thereafter. If, as most founders and service providers hope and expect, the fair market value of the stock is increasing over time, then the amount of income being recognized at each vesting event, and the associated tax bill, will also grow accordingly. If the fair market value of the stock skyrockets over time as the stock vests, this default tax treatment could leave founders/service providers with enormous tax bills but without liquid assets to pay the bill because stock in private companies can be difficult to sell quickly, if at all. Since the income recognition by the founder/service provider is service-related, the company may also have an obligation to withhold taxes at each vesting event. Failure to withhold taxes may result in federal and state consequences for the company, including liability for the amount of unwithheld taxes, interest, and possible penalties.
As an alternative to the above default tax treatment, Section 83(b) of the U.S. tax code allows the founder/service provider to make a filing with the Internal Revenue Service (IRS) and choose to recognize all of the income associated with the stock upfront at the time of purchase/receipt of the stock. The amount of income recognized is equal to the difference between the amount paid for the stock and the fair market value of the stock at the time of purchase/receipt. Making an 83(b) election results in there being one taxable event based on the date of purchase/receipt of the stock instead of many taxable events based on future vesting dates. The major advantage of making an 83(b) election is that, usually, the fair market value of the stock being purchased/received by a founder/service provider is very low and the price being paid by the founder/service provider for the stock is very low (in most cases, equal to the fair market value); therefore, very little income would be recognized (zero, if the amount being paid and the fair market value for such stock were the same) and very little taxes would be due (again, zero, if the amount being paid and the fair market value for such stock were the same). An additional benefit of making an 83(b) election is that there is less required recordkeeping for the founder/service provider, and the company only needs to withhold taxes once (if applicable), due to there being only one taxable event. Last but not least, making an 83(b) election starts the clock for the founder/service provider on the long-term capital gains holding period for all of the stock on the date of purchase/receipt. The default tax treatment, in contrast, is that the holding period for a share of stock does not begin until the stock vests.
How do you make an 83(b) election filing?
Contact the company from which you purchased/received your stock to obtain an 83(b) election form and instructions if you did not get such documents at the time you purchased/received your stock. Not all 83(b) election forms will look exactly the same, but they must contain specific information required by tax regulations. The company may also provide you with a template cover letter, which you will send with the 83(b) election form, to request that the IRS acknowledge your filing by mailing back to you a stamped copy of your form. When making an 83(b) election filing, you will need to keep copies of several items (and provide copies of these items to the company) as evidence that you have made the filing properly and on time. It is likely that counsel to future investors in the company or potential acquirers of the company will ask to view this evidence because of the potential for negative tax consequences due to missed 83(b) election filings. It is recommended that you keep several different kinds of evidence of filing because the IRS may not always return a stamped copy of the 83(b) election form, or it may get lost or delayed in the mail on the way back to you.
If you did not receive instructions from your company, or if you need additional guidance, then you can use the following instructions to make an 83(b) election filing within 30 calendar days after the date you purchase/receive stock that is subject to vesting:
- Fill out the information required on the 83(b) election form and manually sign the form with ink. The IRS does not currently allow electronic signatures for this filing. Make at least one physical copy of the completed and signed form (or up to three physical copies if you do not also make a digital copy). Complete the cover letter to the IRS.
- Using USPS certified mail, return receipt requested, or an IRS-approved private delivery service, listed here, mail the cover letter with the original completed 83(b) election form and the first physical copy of the completed 83(b) election form, along with a self-addressed stamped envelope, to the IRS Center where you would normally file your tax returns. You can find the correct IRS Center address by searching for the phrase “where to file” on www.irs.gov or calling 1-800-829-1040. Notice that private delivery services require the physical street address for delivery to the IRS Centers, which are listed here.
- Keep your receipt of mailing (which should contain the date of mailing) as evidence that you made the filing on time. If convenient, take a picture of the postmarked envelope or package at the post office or shipping location when you send it.
- Keep your certified mail return receipt or other tracking information as additional evidence that you made the filing on time.
- Keep the second physical copy (or a digital copy) of the 83(b) election form, and the IRS-stamped first physical copy of the 83(b) election form when it is returned, for your records.
- Deliver the third physical copy (or a digital copy) of the 83(b) election form, and a copy (digital is fine) of the IRS-stamped first copy of the 83(b) election form, to the company for its records.
Notice that there is a strict deadline associated with making an 83(b) election. An 83(b) election filing must be mailed to the appropriate IRS office and postmarked within 30 calendar days after the date you purchase/receive your stock. The postmark date is deemed to be the date of the filing. Missing an 83(b) election deadline means that the default tax treatment and the associated adverse tax consequences will apply to the stock, the taxpayer, and the company. Unfortunately, there are no simple, perfect, low-risk, or inexpensive solutions for a missed 83(b) election filing deadline.