By Helen Reeves
If you are negotiating to receive equity from a startup company and the equity will be subject to repurchase by the company (often referred to as “vesting”), then you should be aware of a tax election that could provide significant tax savings to you in the future. That election is called an “83(b) Election” and is made by filing an 83(b) Election Form with the United States Internal Revenue Service.
By filing an 83(b) Election Form, a recipient of equity elects to recognize the value of all equity at the time the grant is made, rather than waiting until vesting restrictions with respect to that equity lapse. The impact of this is that a recipient of equity will pay all ordinary income taxes with respect to the grant right away, instead of in accordance with their vesting schedule.
Why would you want to recognize the income tax associated with receiving equity before you have to? Well, if you’re receiving equity in an early-stage business, you’re betting that the value of that equity will increase as the business grows. So if you make an 83(b) election and recognize the income early on, then the taxes that you end up by paying on equity will likely be lower than what you’d pay if you waited until the time when the equity vested.
Sounds great, right? Well, here are some key points to be aware of:
- Vesting. Keep in mind, you can only file an 83(b) election on restricted stock that is subject to vesting (meaning it can be clawed back and repurchased by the Company). So if you get restricted stock but it’s not subject to vesting restrictions, you’ll recognize the income associated with that grant right away and 83(b) isn’t relevant.
- Timing. If you choose to make an 83(b) election, you must do so within thirty (30) days of the date the equity is issued to you. This date is the postmarked date of the mailing of your 83(b) election. No exceptions.
- Do The Math. If you’re being issued the equity at a nominal or fairly low price, then it will likely make sense to file an 83(b) election. Since the value of the equity is so low, you won’t pay much in ordinary income tax. This is why virtually all founders receiving equity upon formation of their company should file an 83(b) election. Ultimately though, if you are a service provider receiving equity in a more mature company or a senior hire receiving restricted stock in growth stage company that’s already received financing, you will need to do the math and assess whether early income tax recognition makes financial sense for you.