When startup founders, employees, or investors receive equity compensation in the form of restricted stock or early-exercised stock options, they may face tax liabilities as the stock vests over time.

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The 83(b) election allows individuals to pay taxes on their stock grants at the time of receipt, rather than when the shares vest. Filing an 83(b) election can help those who expect their company’s stock value to appreciate lock in a lower tax rate, avoid unexpected future tax burdens, and maximize their long-term gains.

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However, failing to file an 83(b) election on time can result in substantial financial consequences. This guide will walk you through everything you need to know to ensure a smooth filing process.

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What Is an 83(b) Election?

An 83(b) election is a provision under the U.S. tax code that allows individuals who receive restricted stock or stock options to pay taxes on their equity at the time of granting rather than when it vests.

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By making this election, the recipient locks in the stock’s current fair market value for tax purposes, potentially reducing their tax burden if the stock appreciates over time.

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An 83(b) election is relevant for:

• Restricted Stock Awards (RSAs): These are shares granted to employees or founders, usually subject to a vesting schedule. Without an 83(b) election, taxes are owed each time shares vest, based on their value at that time. By electing 83(b), the recipient pays taxes upfront at the stock’s lower initial value.
• Early-Exercised Stock Options: Some companies allow employees to exercise their stock options early before they vest. If an employee early-exercises and files an 83(b) election, they pay taxes on the stock’s value at the time of exercise rather than at each vesting date when the stock might be worth more.

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Illustration of the Tax Implications

Let’s say Daniel, a startup founder, is granted 100,000 shares of restricted stock in his company at a fair market value of $0.10 per share. The shares vest over four years.

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Case 1: Daniel Files an 83(b) Election

• He pays tax upfront on the total value of the stock at grant:

• Taxable income = 100,000 shares × $0.10 = $10,000
• If his tax rate is 30%, he owes $3,000 in taxes.

• In four years, the company grows, and his shares are worth $5 per share (total value: $500,000).
• Since he already paid taxes at the lower valuation, any future gains are taxed at the lower long-term capital gains rate when he sells.

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Case 2: Daniel Does Not File an 83(b) Election

• He does not pay tax upfront and instead gets taxed as shares vest.
• Each year, he vests 25,000 shares. Suppose the share price rises to:

• Year 1: $1.00 → Taxable income = $25,000
• Year 2: $2.50 → Taxable income = $62,500
• Year 3: $4.00 → Taxable income = $100,000
• Year 4: $5.00 → Taxable income = $125,000

• He now owes much higher taxes each year because the stock value increased. Also, the income is taxed at ordinary income tax rates, which are higher than capital gains rates.

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Who Should File an 83(b) Election?

An 83(b) election is not for everyone, but for certain individuals, it can be an effective tax-saving strategy. Here are the groups who benefit the most from filing:

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Startup Founders Receiving Restricted Stock

Startup founders often receive restricted stock as part of their initial equity compensation. Since this stock is subject to vesting over time, the IRS treats it as income as it vests, meaning founders could face a hefty tax bill in the future if the company grows.

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By filing an 83(b) election, founders can:

• Pay taxes upfront at the initial (often low) valuation.
• Avoid higher taxes later when the company scales and the stock’s value increases.
• Lock in long-term capital gains treatment on any future appreciation.

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Employees Granted Stock Options with an Early-Exercise Feature

Some companies allow employees to exercise their stock options, meaning they can purchase their shares before they fully vest. If an employee exercises their options early, they technically own restricted stock, which means they face the same tax treatment as startup founders.

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Filing an 83(b) election can help employees:

• Pay taxes on the stock’s fair market value at the time of exercise rather than when it vests at a potentially higher valuation.
• Convert future gains into long-term capital gains, reducing their tax rate.
• Avoid unexpected tax burdens on vesting schedules.

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Investors or Advisors Receiving Equity Compensation

Investors and advisors who receive equity as compensation also benefit from an 83(b) election. Since their stock is often subject to vesting schedules, they could face unexpected tax consequences if they don’t file.

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By making an 83(b) election, they can:

• Reduce their tax burden by paying early when stock value is low.
• Maximize capital gains treatment on future stock appreciation.
• Avoid the risk of a higher tax bill when stock vests.

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Benefits of Filing an 83(b) Election

Here are the main benefits of filing an 83(b) election:

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Lock in a Lower Tax Rate by Paying Taxes Early

When restricted stock is granted, its fair market value (FMV) may be relatively low, especially in an early-stage startup. By electing to recognize income at this lower value, the recipient pays a smaller amount in taxes today, rather than waiting until the stock vests, when it may be worth significantly more.

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For example, if a founder is granted 100,000 shares at $0.01 per share ($1,000 total value) and files an 83(b) election, they will only pay taxes on the $1,000.

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However, if they do not file and the stock vests when it is worth $10 per share ($1,000,000 total value), they will owe ordinary income tax on the full $1,000,000, which could result in a massive tax burden.

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Reduce Tax Liability if the Stock Appreciates

Filing an 83(b) election early allows individuals to freeze their taxable income at the current low stock value. If the stock price increases over time, the increase will be taxed at long-term capital gains rates instead of the higher ordinary income tax rates.

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For instance, if the stock grows from $0.01 per share to $50 per share over five years, the gains are only subject to capital gains tax (usually 15–20%), rather than the much higher ordinary income tax rate (up to 37%).

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This tax-saving strategy can result in significant financial benefits for founders and employees who expect their company’s stock to rise in value.

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Avoid Ordinary Income Tax Treatment on Future Gains

If an individual does not file an 83(b) election, the IRS treats the stock as taxable income when it vests. This means any appreciation before vesting is subject to ordinary income tax rates, which can be as high as 37% (plus state taxes).

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However, by filing the election, all future appreciation after the filing date is taxed at the lower capital gains rate, significantly reducing tax obligations.

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For example:

• Without an 83(b) election, a stock valued at $5 per share at vesting is taxed as ordinary income.
• With an 83(b) election, the recipient locks in taxation at the grant date value, and any future gains are treated as capital gains.

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This tax-efficient strategy allows individuals to maximize their take-home earnings if the stock appreciates.

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Gain Control Over Long-Term Capital Gains Tax Strategy

Filing an 83(b) election also helps individuals exercise control over their long-term capital gains holding period. The IRS requires stock to be held for at least one year after acquisition and two years after grant to qualify for long-term capital gains treatment.

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By making the 83(b) election, recipients effectively accelerate this timeline, thereby ensuring when they sell their stock in the future, they benefit from the lower capital gains tax rate rather than ordinary income rates.

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For instance, if a founder exercises stock options early and files an 83(b) election, they could sell the stock at a lower tax rate within a year or two, rather than waiting for the stock to vest and paying higher income tax rates.

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Step-by-Step Guide to Filing an 83(b) Election

Filing an 83(b) election is a time-sensitive process. Since the IRS enforces a strict 30-day deadline from the date of the stock grant or early exercise, it's important to follow these steps carefully to ensure compliance:

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Step 1: Obtain the Required Documents

Before filing, gather the following documents:

• Stock Grant Agreement or Option Agreement: This document outlines the details of your stock grant or exercised stock options, including the number of shares, vesting schedule, and purchase price.
• 83(b) Election Letter: The IRS does not provide an official 83(b) election form, so you must draft your letter. The letter should include specific details about your stock and an election statement indicating your decision to pay taxes upfront.

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Step 2: Fill Out the 83(b) Election Letter

Your 83(b) election letter should include the following details:

• Taxpayer Information: Your full name, home address, and Social Security Number (SSN).
• Stock Description: Details of the stock grant or exercised stock options, including number of shares, type of stock (e.g., common stock), date of grant or early exercise, fair market value (FMV) per share at the time of grant/exercise, and purchase price per share (if any)
• Election Statement: A declaration that you elect to be taxed under Section 83(b) of the Internal Revenue Code.
• Tax Calculation: The difference between the purchase price and the FMV of the stock (if applicable). If you paid full FMV for your shares, your taxable amount is zero.
• Signature and Date: You must sign and date the form before submission.

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Step 3: Make Copies for Your Records

Before mailing, make at least three copies of your 83(b) election letter:

• One copy for your records.
• One copy for your employer.
• One copy to be mailed to the IRS.

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Keeping copies will help you in case of any discrepancies or future tax audits.

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Step 4: Mail the 83(b) Election to the IRS

• Address it correctly: The IRS has multiple processing centers, and the correct mailing address depends on your state. Check the IRS website or consult a tax professional to find the right address.
• Use certified mail: Send your 83(b) election via Certified Mail with Return Receipt to ensure delivery confirmation.
• Include a self-addressed stamped envelope: This helps the IRS return a stamped copy of your election for your records.

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Step 5: Inform Your Employer

Your employer needs a copy of your 83(b) election for their payroll and tax records. Some companies may also require you to fill out additional paperwork to document the election in their internal systems.

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Step 6: Keep Proof of Filing

Once the IRS processes your 83(b) election, they will return a stamped copy if you included a self-addressed stamped envelope. This document serves as proof of timely filing, which is important during an IRS audit.

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Common Mistakes to Avoid

Timing is everything when filing an 83(b) election. The IRS imposes a strict 30-day deadline from the date you receive your stock, and missing this window can result in significant tax consequences.

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Unlike other tax filings, there are no extensions or exceptions. Hence, you must act quickly and correctly. Even if you meet the deadline, certain mistakes can render your 83(b) election invalid. Here are some errors you must avoid:

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Forgetting to Sign the Form

It may seem obvious, but failing to sign the 83(b) election letter is a frequent mistake. An unsigned form is considered invalid, and the IRS will not process it. Always check your document before mailing it.

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Sending the Form to the Wrong IRS Address

The IRS has specific addresses for different regions, and sending your form to the wrong office can delay processing or result in it being lost. Consult a tax professional for the right address

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Filing Beyond the 30-Day Window

As mentioned earlier, late filings are automatically rejected. If you don’t file in time, you lose the tax benefits of the election and will have to pay ordinary income tax as your stock vests.

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Not Informing Your Employer

After filing your election with the IRS, send a copy to your employer. Some companies have internal policies that require proof of your 83(b) election for their records. Failing to notify your employer may create complications with your tax reporting.

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Wrapping Up

Filing an 83(b) election is a smart financial move for startup founders, early employees, and investors receiving equity compensation. By electing to pay taxes upfront when the stock is granted, rather than waiting until it vests, you can lock in a lower tax rate and potentially save thousands of dollars in future tax liabilities.

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The main benefits include a lower tax burden by paying taxes when the stock has a low valuation, access to long-term capital gains tax rates if you hold the stock for more than a year after filing and avoiding unexpected tax bills that can arise when shares vest at a higher valuation.

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Filing an 83(b) election within the strict 30-day window ensures you take advantage of these tax benefits before your stock appreciates significantly. Since missing this deadline can lead to costly consequences, you must stay informed and be proactive.

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While an 83(b) election offers significant tax advantages, it’s not the right choice for everyone. If your startup fails, you might end up paying taxes on stock that becomes worthless.

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Consult a qualified tax professional or CPA to make the right decision. The professional will evaluate your financial situation and advise whether filing an 83(b) election aligns with your long-term financial goals.

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FAQs

What happens if I don’t file an 83(b) election?

If you don’t file an 83(b) election within the required 30-day window, you will be taxed on your equity as it vests rather than at the time of grant or early exercise. This means:

• You could owe ordinary income tax on the difference between the fair market value (FMV) of the stock at each vesting date and the price you paid for it.
• If the stock’s value increases over time, your tax liability could be much higher unlike paying upfront at the time of grant.
• You may have to pay taxes on income you haven't yet received in cash, leading to liquidity issues.

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Can I revoke an 83(b) election after filing?

No, an 83(b) election cannot be revoked once filed, except in rare circumstances where the election was invalid due to a legal or procedural error. Even if the stock decreases in value or becomes worthless, the election remains in effect. This is why you must evaluate your financial situation and the startup’s potential before filing.

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What if my startup fails—will I lose money?

Yes, there is a risk. If your startup fails and the stock becomes worthless, you will have already paid taxes on the initial fair market value. However:

• You cannot get a tax refund for the taxes you paid due to the 83(b) election.
• You might be able to claim a capital loss on your tax return, which can offset other capital gains or reduce taxable income (subject to IRS limits).

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