If a founder or employee receives stock subject to vesting, he or she should consider making an 83(b) election. Under Section 83(a) of the Internal Revenue Code, stock (and other property) received in exchange for services is taxable in the year of receipt based on the difference between the fair market value on the date of receipt and the purchase price. However, if the property is subject to forfeiture or is not transferable, the recipient does not have any taxable gain until those restrictions lapse.

The most common restriction on stock for founders is vesting. Under Section 83(b), the founder or employee can disregard the forfeiture restrictions (i.e., vesting restrictions) and elect to take the gain in the current period. For most founders, the election is a wise choice because the fair market value is equal to the purchase price and the taxable gain is zero. If the election is not made every time the stock vests, the holder has taxable gain on the difference between the fair market value at that time and the purchase price even though the stock likely is not liquid and even though the holder is not selling any stock. In other words, the holder is taxed on phantom income.

Another advantage of an 83(b) election is that it starts the holding period for capital gains purposes.

83(b) Election Form

The IRS has not set forth the specific requirements for an 83(b) election, but there are a number of forms that are all very similar and have the following information:

• Name, address, and tax identification number (or social security number) of the recipient.
• Description of the shares.
• The date on which the shares were transferred and the tax year for which the recipient is making the election.
• Restrictions on the stock.
• The fair market value of the shares at the time of the transfer (on an aggregate or per share basis).
• The amount paid for the stock, if any.

How to File the 83(b) Election

An 83(b) election is effective only if the purchaser files the form with the IRS where the purchaser files his tax returns before the date of purchase or within 30 days after the date of purchase. The IRS does not give a purchaser a grace period — 30 days is 30 days. The 30 days are calculated by starting with the calendar day after the date of purchase as day 1 and then counting to 30. The date the election is mailed with a postmark is the date of filing, but many practitioners advise to startups to make sure the form is received by the IRS by the 30th day.

An 83(b) election must be filed within 30 days of the date of purchase (technically the date of transfer under the Code).

We recommend sending the election by certified mail, return receipt requested, and include a copy of the letter with a self-addressed and postage paid envelope and a request in the letter to the IRS to stamp the second copy and to return to the filer using the enclosed envelope. In case the IRS does not return the stamped form, the filing founder should keep a copy of the form he filed with the IRS. The filing founder should also include a copy of the 83(b) election with his or her federal income tax return for the year the purchase occurred.

More information on Section 83(b) is available in IRS Publication Number 525 which is available on the Internal Revenue Service’s website.