If you’re a first-time founder, you may have never heard of a section 83(b) election before. I know the first time I heard about the 83(b) filing was when our corporate lawyers told us we had 30 days to sign and mail these important documents. Between printing, signing, and shipping, I spent 2 hours carefully putting together the required materials for myself and my co-founder (you’re welcome Collin! :)).
While tedious, an 83(b) election is important to ensure you don’t get hit with a hefty tax bill down the line. This election is especially important for all founders with a large percentage of equity.
Given how much of a pain it was to handle the 83(b) election, and the number of questions we get asked at Stable from founders who have recently incorporated, we’ve written this article to break down the following questions so it’s easy to understand:
1. What is an IRS 83(b) election form?
2. What are the 83(b) tax implications?
3. How to file and where to mail 83(b) election?
4. How to confirm the IRS received your 83(b) filing?
This post is aimed for founders and entrepreneurs. If you’re an employee, I’d recommend checking in with your accountant to see if this option makes sense for you because the tax implications may be more complicated.
The 83(b) election gives founders the ability to pay taxes on the total fair market value of restricted stock on the date of its grant, instead of when it vests.
A Simple Example
When you incorporate your company, you’ll likely issue shares for co-founders in the company. Many Delaware C-Corporations will initially issue 10 million shares with a very, very low share price. For instance, you may set a share price of $0.00001 per share at incorporation. Because the company has not generated any revenue or value yet, this share price is the lowest it’ll ever be, and founders get to reap the benefits of that.
For simplicity, If you have two co-founders who own fifty percent of the company each (in actuality, you may set aside some shares in an option pool for employees and advisors, but we’re not going to get into that), this will mean the stock is worth $50 (5,000,000 shares x $0.00001).
So, $50 becomes the “total fair market value of restricted stock on the date of its grant” and the date of the grant is the incorporation date or soon after. As a founder, you’ll “pay” $50 to the company for these shares and likely be put on a 4 year vesting schedule.
Now that we’ve established that you own $50 of your company valued at $100, let’s jump into how this can affect your taxes over time. First, you probably incorporated your company to generate revenue and build a meaningful business. Whether you’re aiming for your company to be worth $1 million or $1 billion dollars one day, the value of your company will affect the share price.
Let’s say your company is in fact a unicorn (yay!) one day. At a $1 billion dollar valuation, and again for simplicity assuming no additional issued shares, dilution, or additional shareholders, those shares you once paid $50 for are now worth $500 million! Woo, you’re rich!
Not so fast though, there are tax implications on that earning.
In short, receiving restricted stock requires the founder to pay the value of the stock on their individual income tax. Filing an 83(b) election enables you to pay that tax liability upfront for all shares. Otherwise you will need to pay income tax on the value as it vests every year, which is also complicated to keep track of.
Additionally, when you liquidate your shares, you will pay a capital gains tax on the earnings. This is usually less than how much your individual income tax will be, especially if it is a large amount.
Let’s look at what could happen in both scenarios:
$100M is a lot of money but now let’s look at what happens if you didn’t file an 83(b) election.
In this simplified scenario, you would save over 42 million if you had filed the 83(b) election form. Seems like a pretty good deal for only filling out a form and sending it in, eh?
In short, because capital gains tax rate is lower than income tax rate for high sums of money, this gives you a tax advantage to categorize the majority of the earnings as capital gains, instead of income.
† Note that the actual income tax would be very slightly less since you can take advantage of lower tax brackets up to ~$500K in earnings. But again, because we’re riding on simplicity and will likely have other income, we’re assuming the highest income bracket.
Now that you understand what an 83(b) election is, there are specific steps to take to file your 83(b) election and obtain proof of filing in the case that you’re ever audited by the IRS down the line.
Reminder: you have 30 days to file from the date of your stock grant to file this form
The steps for how to and where to mail 83(b) election are outlined below:
First, you’ll need to sign the 83(b) election form typically attached to your Stock
Purchase Agreement. Your law firm or incorporation service should have generated this document for you as part of issuing stock. If not, you can use this template from the IRS.
If you signed using a wet signature, you’ll also want to scan a copy of the document for your records.
You’ll need to create a cover letter that contains the following information to send with the filing:
Note: Your law firm or incorporation service may provide this for you.
Print or photocopy the signed 83(b) election form and the cover letter. In total, you should have at least two copies of your 83(b) election form.
In a large envelope, prepare the following documents for mailing:
Go to your local Post Office to mail the filing. You should mail your 83(b) election filing to the same address that you would mail your tax returns to. Depending on your state, the address may differ:
Our law firm recommends sending the 83(b) election through USPS Certified Mail in order to receive a green mailing receipt once you mail the documents. This green mailing receipt can be retained as proof that you’ve made the filing.
When mailing in your 83(b) election, you should include a self-addressed and stamped envelope so that the IRS can mail a copy back to you. In your cover letter, you should include instructions similar to the following:
Please acknowledge receipt of the enclosed 83(b) election form by date-stamping the two additional copies enclosed of this election and returning them in the envelope provided.
By providing the additional copies of your 83(b) election, including a return envelope with postage, and clearly outlining instructions, the IRS will send back a copy of your 83(b) election in the mail to the specified address. When received, you should scan a copy of it for your records.
If you need a US address to receive the returned 83(b) election from the IRS, you can use a virtual mailbox service like Stable (50% off discount for newly incorporated businesses). With a virtual mailbox, you’ll be notified when you receive the copy of the 83(b) filing and a copy of this filing will be digitally and securely stored.
Overall, the 83(b) election can be a pain to file, but it is worth the tax benefits for a founder. Being able to take advantage of a lower tax rate for the majority of your earnings can add up in the event of an acquisition or IPO.
These are detailed instructions to follow on how to compliantly file your 83(b) election — and remember, if you’re looking to have a safe place to receive and digitize the returned 83(b) election from the IRS, you can use a virtual mailbox service like Stable (50% off discount for newly incorporated businesses).
At Stable, we provide permanent virtual addresses and mailboxes so you never have to worry about mail or changing addresses again. We’ll digitize all mail that you receive here, and you’ll be able to scan, forward, shred, (and even deposit checks!) from anywhere in the world.
Get started with Stable here if you’d like a virtual business address + mailbox in less than 3 minutes.
Disclaimer: Stable is not a legal or accounting firm, therefore we cannot provide legal or tax advice. You should consult legal and tax professionals for advice on how to meet ongoing obligations that apply to you and your company.