83(b) Election Basics
Every founder should file an 83(b) election.
When a founder receives restricted stock (i.e., subject to vesting), they can file an 83(b) election within 30 days of the grant date. This means they pay ordinary income tax on the fair market value (FMV) at the grant rather than at each vesting milestone. If you don’t file it, then you pay income tax later when the stock vests, which could be worth much more.
Let’s think of some numbers. Imagine a stock grant with a 4-year vesting period where:
- You receive 10,000 shares.
- The Fair Market Value (FMV) at grant is $0.10 per share, resulting in a total value of $1,000.
- After 4 years, the company does well, and the stock price is $50 per share, resulting in a total value of $500,000.
Below, I compared the case where you file and do not file an 83(b) election. You can see why you can potentially save a lot of tax money by filing it.
| Case 1: Filing 83(b) Election (Pay Taxes Now) | Case 2: Not Filing 83(b) Election (Pay Taxes Later) | |
|---|---|---|
| Day 1 Stock FMV | $1,000 | $1,000 |
| Taxable Income at Grant | $1,000 | $0 |
| Income Tax Rate | 30% | 30% |
| Income Tax Owed at Grant | $300 | $0 |
| Stock Value After 4 Years | $500,000 | $500,000 |
| Taxable Income at Vesting | $0 (already taxed) | $500,000 |
| Income Tax Owed at Vesting | $0 | $150,000 |
| Capital Gains Tax Rate | 20% | 20% |
| Capital Gains Tax Owed | $99,800 (20% of $499,000 gain) | Depends on future growth |
| Total Taxes Paid | $300 now + $99,800 later = $100,100 | $150,000 (income tax) + capital gains tax later |
As shown in the comparison, paying a small tax upfront can lead to massive tax savings in the long run. By locking in the fair market value early, you avoid hefty income taxes on future appreciation and instead benefit from lower capital gains taxes when selling your stock.