Simply put, a Section 83(b) election is a tax code election made by someone who is receiving shares over time.

Consider the following: if a founder just started a company, they might go on a three to four year vesting schedule, with a one year cliff, meaning that they earn nothing in year one but receive shares at monthly or quarterly vesting milestones thereafter.

The US Tax Code specifies that any property (including shares of stock) received in exchange for services is taxed at ordinary income rates. This means that the government will tax you on the fair market value of the stock over the price paid for the stock (usually $0 for a founder) on the date at which it becomes substantially non-forfeitable (the date in which those shares “vest”).

For a company that has just started and has issued shares to founders valued at some negligible amount (usually a fraction of a cent), this is not a big deal. The taxable income is almost nothing. On the other hand, the value of those shares may have increased significantly at the second or third vesting milestone if the shares vest over time. You will then have to pay a significantly higher amount of tax on those shares as they vest.

If that seems a bit unfair, given the high amount of risk you’ve undertaken getting your startup going already, fear not! The Section 83(b) election allows an individual to pay the taxes on all the shares that vest over time, as if they were all vested on day 0, rather than on the day the shares actually vest, thus saving quite a bit of money.

Check out the Section 83(b) election form on Clausehound and click through the tags to learn more!

Author: Phil Weiss and Sahil Kanaya

 

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