1. What is a 83(b) election ?
It is common for start-up founders and key employees to receive a standard “Restricted Stock Purchase Agreement” with a vesting schedule. Under this document, the company has the right to buy back these stocks if he or she is terminated or leaves the company. Section 83(b) election provides an opportunity to elect to be taxed at the time of the receipt of the property (e.g., grant date) instead of waiting for the property to become transferable, or no longer subject to a substantial risk of forfeiture (e.g., vesting date).
So basically, 83(b) election is a form you send to the IRS letting them know you’d like to be taxed on your equity on the grant date rather than the vesting date.
Section 83(b) election is applicable only for stock that is subject to vesting, since grants of fully vested stock will be taxed at the time of the grant.
2. Why 83(b) Election is so important to startups ?
The 83(b) election is extremely useful and can result in great tax savings under this situation. Without an 83(b) election, a startup founder or key employees may end up with a large tax bill at a time when their stock is still illiquid. By selecting the election, ordinary tax rates (max 37%) on higher values at vesting periods can be prevented and will accelerate the holding period, which will allow for any gain at sale or liquidation to more quickly be recognized as capital (max 20%). Capital assets are subject to the favorable taxable rate if held for a year or more.