83(b) election

What is an 83(b) election?

An 83(b) election is a form that enables recipients of restricted securities (including stock options) to potentially lower their tax burden by paying taxes on the total fair market value (FMV) of the award at the time of issuance ( early exercising). Employees and founders must file an 83(b) election form with the IRS to get this favorable tax treatment.

When a company grants you an equity award, you usually can’t exercise the award until it vests. And if you have a typical four-year vesting schedule, the value of your equity may increase significantly over that time. By the time you can exercise, it could cost you a lot more if you owe higher taxes resulting from the increased value of your equity.

But some companies allow employees to exercise their equity early—before it vests and while the value is lower—allowing for potential tax savings in the future. Here’s the catch: If your company offers early exercising and you purchase your equity before it vests, you must inform the IRS by filing an 83(b) election. Otherwise, it’s as if the early exercise never happened (from a tax perspective).

Note: This information is a general overview of how the 83(b) election works. Exercising stock options carries the risk that the shares will not increase in value and may not be worth anything. Talk to a tax advisor before making decisions about whether to file.

The benefits of filing an 83(b) election

The tax impact of exercising stock options can keep startup employees from unlocking the power of their equity. Not everyone has cash available to pay a hefty tax bill—and if you work for a private company, you may not be able to sell your shares for quite a while. A lower tax bill could make ownership possible for more employees. 

Meanwhile, starting a company or joining at the very early stages involves taking a substantial risk. The possibility of a tax break can help motivate people to take that risk and build something new.

Tax implications of an 83(b) election

The tax implications of an 83(b) election vary by the type of equity you hold.

ISOs and NSOs

With these two types of stock options, you’ll file an 83(b) election if you decide to exercise your options early, before they’re fully vested. When you do, you’re basically accelerating the spread between the strike price of your options and their fair market value. That means you’re not paying taxes on any potential rise in that spread as your shares continue to vest over time. If you don’t file the election, though, it’s as if your early exercise never happened.

If you have incentive stock options (ISO) when you file an 83(b) election, the spread between the FMV and your exercise price is included as income for the alternative minimum tax (AMT). Without an 83(b), you may have to pay AMT on the spread between the strike price and the FMV as you continue to vest — instead of the spread at early exercise. This could potentially trigger the AMT or lead to a higher AMT.

If you have non-qualified stock options (NSO), that same spread is income for ordinary income tax purposes. Failing to file 83(b) election will mean that you’ll be subject to a higher income tax rate if the FMV increases as your options vest.

With both types of stock options, if you hold your shares for a period of time before selling, you may be subject to lower tax rates when you sell. The earlier you exercise and hold your shares, the earlier those holding requirements kick in.

→ Learn more about stock option taxes.

RSAs 

Founders and very early-stage employees often receive restricted stock awards (RSA). The value of these can vary based on the company’s fair market value, but they’re typically issued at a nominal value (like $0.001 or $0.0001 per share). This means that if you file an 83(b) election when you receive your RSAs, you’re likely to have very limited tax liability because you’re recognizing that spread (which is zero or very, very small) as ordinary income tax up front. When you eventually sell these shares, you’ll be subject to capital gains tax on the difference in FMV at the time of sale. 

Without an 83(b) election, the spread between the FMV at vest less your purchase price would be subject to ordinary income tax.

Profits interests in an LLC or partnership

Profits interest units (PIU) are a type of equity typically issued to employees in a limited liability company (LLC). They are a restricted share that gives the holder a right to a portion of the future value—typically of future profits or a sale—of the company under certain restrictions. When an 83(b) election is made, the tax advantage of PIUs is similar to that of ISOs issued from a C-corp. 

Most LLCs require 83(b) elections to preserve the favorable tax status of profits interests. If PIUs are issued with an FMV of $0 (as they generally are), the recipient won’t pay taxes at the time this election is made. If an 83(b) election isn’t made within 30 days, the award could be taxed upon vesting—before the holder begins to realize any of the value of profits interest.

The 30-day 83(b) election deadline

If you exercise early and don’t make an 83(b) election within 30 days, you won’t get the tax benefit. So if the company’s valuation has increased and you haven’t filed an 83(b), you’ll pay more in taxes when your shares vest or you sell them in the future (depending on your grant type). 

Beyond the liability for the employee or founder, this can also create tax issues for the issuing company. 

How to file form 83(b)

To qualify for preferential tax treatment, your 83(b) election form must be postmarked and mailed to the appropriate IRS office within 30 days of the date of your restricted stock grant or the date of your early exercise. 

You should contact your tax professional to review your Section 83(b) election before filing with the IRS, and to assist with the filing process. Non-individual purchasers (e.g. corporations or trusts)  should contact legal and tax professionals licensed in their jurisdiction.

The process for submitting this form has several steps, and can be burdensome. Here’s what the IRS requires: 

• A signed, completed 83(b) election form mailed to the appropriate IRS office

• A copy sent to the issuing company

It’s also common to include a cover letter for the IRS and a copy of the form (in addition to the original signed form) with a stamped, self-addressed envelope, though it’s not required.

When you fill out the form, you’ll need to provide the following information:

• Name

• Address

• Social security number (SSN)

• Number of shares

• Type of shares

• Issuing company name

• Date granted or purchased

• FMV on the above date

• Amount paid for shares

• Your gross income

After filling out the 83(b) form and creating a cover letter, make at least three additional copies.

Where to mail the 83(b) election form

Mail the original completed and signed election form and cover letter, along with one copy of the 83(b) election form and a self-addressed stamped return envelope to the IRS Center where you would otherwise file your tax return. Sending the election via certified mail, requesting a return receipt, with the certified mail number written on the cover letter is recommended. 

Then mail one copy to your company, and also keep  a copy for your permanent records. 

→ Learn more about filing 83(b) elections on Carta’s Support site.