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Everything you need to know about the 83(b) election
Table of Contents
- What is the 83(b) election?
- Why is it important?
- How much time do I have to make the 83(b) election?
- When is this relevant?
- Let’s get practical. What do I need to know about actually making this filing?
- I’m not a U.S. citizen or resident. What do I need to know?
- Could you bring an example?
- What about capital gains tax?
- The total difference is only about $80,000…
- What are some other resources I can check out on this topic?
What is the 83(b) election?
In the simplest terms: it’s a tax form you send to the IRS, saying that you’d rather pay any taxes due upon your stock grant today rather than later as the stock vests.
Why is it important?
Simply put, filing the 83(b) election can help lower your tax liability. More importantly, it can help you to avoid a surprise tax bill that you have to pay from your personal funds. Eduard Grigoryan, senior associate at Latham & Watkins, explains it in crisp terms in this clip:
How much time do I have to make the 83(b) election?
30 days! This is a hard and fast rule, no exceptions. From the moment the company transfers you stock, you have 30 days to properly file your 83(b) election with the IRS. Here are some pointers:
- To be on the safe side, use the earliest relevant date to calculate when the 30 days starts ticking. For example: if the Board approved your grant on May 1 and your restricted stock purchase agreement is dated May 10, base your calculations off the May 1 date.
- If you’re unsure about the date the stock was transferred, a good rule of thumb is to use the date your stock purchase agreement was entered into. You’ll find this at the very top of the agreement.
- Sometimes, the restricted stock purchase agreement refers to its date as “the last date set forth on the signature page.” In that case, scroll down to the signature page of the agreement and select the latest date of signature.
- Your 83(b) election has to be postmarked within this 30-day time period. In other words, the post office or carrier has to have accepted your mailing within this time period. When it reaches the IRS is irrelevant.
- If the 30th day falls on a Saturday, Sunday, or legal holiday, the time to file is extended to the next business day.
When is this relevant?
An 83(b) election is relevant for:
- Stock that is subject to vesting
It is not relevant for:
- Stock that is not subject to vesting (it’s fully vested from day 1)
- Options
Let’s get practical. What do I need to know about actually making this filing?
Roll up your sleeves, here we do.
What’s the form?
We’ve built a special tool that allows you to prepare your 83(b) election and file it online. It also includes helpful tool tips for each item on the form.
Where do I send my 83(b) election?
Send it to the IRS address where you would normally send your Form 1040. Find your address here.
How should I mail my 83(b) election?
Here are a few pro tips to follow:
- Include two copies of your election, along with a cover letter and a self-address, postage-paid envelope
- Send your mail via USPS certified mail, return receipt requested
- Keep the postmarked certified mail receipt
- Once the mail shows as “Delivered” in the tracking information, get a printout or screenshot of the confirmation
- Keep the return receipt if and once you get it back from the IRS
- The IRS should return a date-stamped copy of your 83(b) election, in acknowledgement that they’ve received your filing. Keep this is and once you receive it.
What should I write for #4 (transfer restrictions)?
This ultimately depends on what your restricted stock purchase agreement says. Is your stock subject to a repurchase option or forfeiture? Will the company be taking it back at fair market value or the price you originally paid for it – or whichever is less?
In our automated form we’ve included sample language for your consideration that should cover a majority of cases: the Shares are subject to forfeiture or repurchase in favor of the Company under the terms of an agreement between the taxpayer and the Company. The risk of forfeiture or repurchase lapses over a specified vesting period.
I’m not a U.S. citizen or resident. What do I need to know?
Fret not. Here are the most important aspects of the 83(b) election that you should now.
Why should I file this if I don’t pay U.S. taxes?
Your stock is going to vest over a period of time (normally, four years). If there’s a chance that you might move to the U.S. and/or become a U.S. taxpayer during that timeframe, it’s a good idea to err on the side of caution and file your 83(b) election just in case.
Where do I send my 83(b) election if I’m not a U.S. resident?
You can find the address here. Better yet, use our service and we’ll send it to the IRS for you.
How should I send my 83(b) election if I’m not a U.S. resident?
If you have a contact in the U.S., you can ask them to mail your election for you. Otherwise, you should use a carrier such as FedEx or DHL for the mailing – but make sure you use a designated service, listed here. Better yet, use our service and we’ll send it to the IRS for you.
I don’t have a U.S. Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN). What should I do?
As your (and your spouse’s, if relevant) tax identification number, write “foreign individual” or “N/A”. Some tax professionals recommend applying for an ITIN as soon as you can; other tax professionals suggest applying for one only if it becomes necessary (for example, you’re moving to the U.S. Make sure you consult with a competent tax professional on this.
Could you bring an example?
Sure. Here are some details we’re going to work off of:
- You’re granted 480,000 shares of common stock
- Purchase price per share is $0.00001
- 4-year vesting schedule, 1-year cliff
- Ten months after getting the stock, the company raises a priced round at a $10,000,000 pre-money valuation.
Let’s check out a few scenarios.
1. You don’t pay anything for the stock and file the 83(b) election
The total purchase price of your shares is $4.80 (480,000 shares x $0.00001 per share). You got the shares for free. This means you’ve earned an income of $4.80, and that’s subject to income tax. When you file the 83(b) election, you’re telling the IRS that you want to pay tax on that income now.
Let’s assume your federal income tax bracket is 32%. You’ll end up paying $4.80 x 32% = $1.54 in total ordinary income tax for your 480,000 shares.
2. You pay $4.80 for the stock and file the 83(b) election
Since you’ve paid the full purchase price for your shares, you haven’t received any income through the shares. You file your 83(b) election, and you end up paying $0 in ordinary income tax total for your 480,000 shares.
3. You don’t pay anything and forget to file the 83(b) election
This is where vesting becomes relevant. Your stock is subject to a 1-year cliff. In other words, none of your stock vests until you’ve worked at the company for a year. When you hit that one-year anniversary, 1/4th of your stock will vest (assuming you’re on a 4-year vesting schedule, which is customary). So, in our example, you’ll get 120,000 shares on that one-year anniversary.
But when that anniversary happens, your shares won’t be worth $0.00001 anymore. Assuming the company has 10,000,000 outstanding shares when it does its $10,000,000 priced round, each share will cost $1.00. So, for the IRS, a year after you’ve gotten the stock, you’re getting $120,000 worth of income from your company (120,000 shares x $1.00 per share), for which you haven’t paid anything. Assuming the same 32% tax bracket, your ordinary income tax liability is now $120,000 x 32% = $38,400.
But it doesn’t end there. After you pass the cliff, you’ll start getting shares monthly – 1/48th of the total grant, or 10,000 in our example. That’s $10,000 in income each month (assuming the company valuation doesn’t change through, say, a new priced round), or an additional $120,000 each year. That’s another $38,400 in ordinary income tax liability each year.
You’ll end up paying $153,600 in ordinary income tax over four years. Had you filed the 83(b) election, you could have gotten away with paying $0.
4. You pay $4.80 for the stock and forget to file the 83(b) election
Same situation as above, except that the IRS will take into account that you’ve paid $4.80 for the shares and deduct that from your income. You’ll end up saving a whooping $1.54 in ordinary income tax.
What about capital gains tax?
I’m glad you asked. You’ll notice that I kept on stressing “ordinary income tax” above. That’s because there’s another type of tax that comes into play when you “exit,” or sell your shares: capital gains tax.
Let’s add one more piece of info to this scenario:
- 10 years later, you sell your shares for $100 per share.
Let’s consider both cases: having filed and not having filed the 83(b) election.
1. Having filed the 83(b) election
If you’ve made this filing, the cost basis of your shares is $0.00001. So, when you sell each share for $100, you’re realizing a gain of $99.99999. Across 480,000 shares, that’s a capital gain of $47,999,995.20. Assuming your federal capital gains tax bracket is 15%, you’ll pay $7,199,999.28 in capital gains tax.
This will essentially be your total tax liability (both ordinary income tax and capital gains tax) for your shares, since the ordinary income tax liability is negligible here.
2. Not having filed the 83(b) election
Let’s assume you didn’t make the filing, and each share was valued at $1.00 when it vested. This means that your cost basis for each share is $1.00. When you sell your shares, you’re realizing a gain of $99.00 per share, or $47,520,000, and you’ll pay $7,128,000 in capital gains tax.
This will bring your total tax liability (both ordinary income tax and capital gains tax) for your shares to $7,128,000 + $153,600 = $7,281,600.
The total difference is only about $80,000…
In our example, true. But here’s the real sting of missing the 83(b) election: it’s one thing to pay tax when you actually get a payout. It’s another thing when you have to pay tax without actually getting any payout.
When you sell your shares, you’re getting money, which can be used to pay your taxes. But when you have to pay taxes because your stock appreciated before it vested, you’re not getting any money from which you can pay your taxes. You’ll have to tap into your personal accounts or possibly get a loan just to pay off that tax.
What are some other resources I can check out on this topic?
Here are some other resources for your consideration:
- Corpora.us: Why making the 83(b) election is important from the company’s perspective
- NASPP: 83(b) Election: The Multi-Million-Dollar Ticking Time Bomb
- CooleyGo: What is an 83(b) election and why you should file one
- Smartgate.vc: How to file an 83(b) election from Europe
