Video transcript
Introduction
Majorie Godfrey: Hello. Welcome to this instructional video on 83(b) Elections. I’m Majorie Godfrey, Senior Legal
Editor with Practical Law, and I specialize in venture finance. Today we’ll be answering a few questions on 83(b)
Elections: what it is, what the benefits are, who can file one, what the deadline is and the process, and finally why is
it important in relation to funding and mergers and acquisitions.
What Is an 83(b) Election?
Founders, employees and other service providers of a startup often ask company counsel. "What is an 83(b) Election
and do I need to file one?" This question usually comes up when the recipient is receiving stock or a stock option
that is subject to a vesting schedule.
An 83(b) Election is a tax election where the stock recipient sends a notice or a letter to the IRS stating that they
want to be taxed on the date that the stock is transferred to them rather than when the stock vests, as is the case
under the default tax rules. Although it is an election or process, the letter itself has come to be known as an 83(b)
Election. This stock must be subject to a "substantial risk of forfeiture," which is a technical IRS term. An example of
this is restricted stock granted to a founder under a founder stock purchase agreement that is subject to the
company’s right of repurchase. In other words, the recipient could lose ownership of the stock. An 83(b) Election also
applies to certain stock options that are exercised early before they vest. These are sometimes known as Early
Exercise Options. It is most applicable to the recipients of stock in a high risk startup where the value of the stock is
low, sometimes close to zero, at the date of the transfer but is expected to increase significantly over time.
What Are the Benefits of Making an 83(b) Election?
The benefit of making an 83(b) Election is that it can save the founder a lot of money because it accelerates the
timing of when the founder recognizes the ordinary income tax. It tells the IRS that they want to be taxed on the value
of the stock on the date of transfer when the value is low, as opposed to the later vesting date when the stock value,
and the resulting tax, is potentially greater.
In addition, the holding period for determining whether the capital gain is short term or long term begins at the transfer
date instead of the vesting date. And since long term capital gains are typically taxed at a lower tax rate than the
short term gains on ordinary income, the sooner the holding period begins, the better for the founder.
Finally, counsel should always advise their clients to seek advice from a tax professional before making the election,
as individual circumstances vary and the election can have significant tax implications.
Who Can File an 83(b) Election?
An 83(b) Election is generally available to any recipient of stock that is earned as compensation for services and is
subject to a substantial risk of forfeiture. So the people for whom an 83(b) Election is an option are service providers
of the company. Think founders, employees, directors, advisors and so on. Let’s take a founder for an example. If
they receive restricted stock, the only time they can file an 83(b) election is at the time that the stock is granted or
transferred to them, which is usually the execution date of the restricted stock purchase agreement. If the founder
receives early exercise stock options, they would only be able to file the election if and when they exercise those
options early. The same rules apply to both incentive stock options and non-qualified stock options. The 83(b)
Election does not apply to stock appreciation rights or restricted stock units. For profits interest, there are special
rules and people have different opinions, but recipients usually file one just to be on the safe side.