To 83(b) or Not To 83(b)?

An alert pops up on the top-right corner of my laptop.

It’s a text from a friend.

“Can we chat?  It’s about 83b.”

I pick up the phone and call him then and there.

“What’s up?”

A couple months ago, he received an offer to join a startup, and equity was part of the compensation.  He just remembered my post about this “83(b) thing.”

“The 30-day deadline, I blew it,” he says.

“Hang on.  Did you get stock or options?”

“I got stock.”

“Hmm, is it subject to vesting?”

“I think so,” there’s a silence as he scrolls down his agreement.  “It says here ‘1/4th of the Option…”

“Say no more, you got options instead of stock.  Can you or did you early exercise?

“Early… what?”

“Early exercise.  Search for ‘early’, see if anything comes up.”

I hear clicks as he hits “Enter” on his keyboard.

“Nothing.”

“Alright then, 83(b) is irrelevant.  You’re good.”

“You sure?”

“Positive.”

The Rise of 83(b) Awareness… and Misunderstanding

This story reflects a broader trend – 83(b) elections have skyrocketed in popularity since their inception back in 1969, particularly in the last couple decades as equity compensation has become the norm across several industries.

This has been fueled in part by a plethora of online content, coupled with war stories picked up on the street, all propounding on the importance of this quintessential tax filing, the consequences of missing it, and the urgency of filing it:

30 days! 30 days! You’ve got 30 days!

And in the midst of this rise of 83(b) election awareness, one critical aspect has been overshadowed:

When – for which equity types, exactly – is the 83(b) election relevant?

That’s the purpose of this blog post – to provide a cheat sheet, if I may – of the equity types where the 83(b) election is relevant… and when it is not.

To 83(b)

These are the most common equity types and related scenarios where the 83(b) election is relevant.  By “relevant”, I mean that the election is available should the equity recipient wish to make it.

Restricted Stock

Search for “83(b) election”, and you’ll get pages and pages of hits covering 83(b) elections exclusively in relation to restricted stock.  Founders getting founder stock*.  Advisors getting advisor stock*.  Employees getting common stock.  Companies granting RSAs.  Hires signing RSPAs.

All these words and phrases refer to one thing:

being issued stock that is subject to vesting, aka “restricted stock”.

If you’re getting stock – usually, common stock – that is subject to vesting, and you’re getting that stock as compensation for your services, then the 83(b) election is relevant.

* By the way, “founder stock” and “advisor stock” are misnomers.  Legally, there’s no such thing, and they both refer to the same underlying equity: stock.

Let’s move on.

Profits Interests

As a refresher, a profits interest is an equity interest in an LLC or partnership where, if the partnership’s assets were sold for fair market value and the proceeds distributed immediately after the interest was issued, the profits interest recipient would not receive anything.

A mouthful, I know.

A simpler way of saying this is that the profits interest’s liquidation value is $0.

The 83(b) election is relevant for profits interests.  Now, IRS Rev. Proc. 93–27 and 2001-43 provide guidance on issuing “safe harbor” profits interests, in which case an 83(b) election need not be filed.  That being said, many professional advisers recommend filing a “protective” 83(b) election nonetheless, to avoid unfavorable tax consequences should the profits interest fail to satisfy the safe harbor requirements (for example, if the profits interest is disposed of within two years).

Early Exercise Stock Options

An 83(b) election is irrelevant for stock options per se (we’ll cover why that’s the case below).  However, if the stock option allows the recipient to early exercise and the recipient does so, they essentially get restricted stock as a result – stock, or property, that is subject to a substantial risk of forfeiture.  Thus, in this scenario, the 83(b) election is relevant.

Not To 83(b)

Shifting gears, let’s list some of the equity types and scenarios where the 83(b) election is not available, starting from the last item mentioned above.

Stock options

This is a big one which often confuses your typical founder, employee, or advisor.  If you’re getting a stock option – whether an incentive stock option or non-qualified stock option – and you don’t have the ability to early exercise, or you do have that ability but chose not to, then you can carry on living in peace.  The 83(b) election is not relevant.

Why?

Because Section 83 covers transfers of property, and, for purposes of that section, options without a readily ascertainable fair market value – which is commonly the case for options granted in private companies (sorry, 409A valuation, you don’t count here) – are not considered property.

Restricted Stock Units

As a company matures, restricted stock units tend to become more popular as elements of equity compensation.  However, they’re also not subject to Section 83 for the same reason as stock options: they’re not considered property within the meaning of that section.

Fully vested stock

Coming full circle, we’re back to stock, but this time, it’s fully vested rather than restricted.  In order to come within the scope of Section 83, equity has to be subject to the substantial risk of forfeiture.  That’s what vesting is: the recipient’s rights in the stock are conditioned upon their future performance of substantial services for the company.

Stop performing those services, and the stock is forfeited back to the company.  However, when the stock is fully vested, there is no such risk – and, so, there is no 83(b) election.

Conclusion

When inundated with all the content on 83(b) elections, it’s easy to lose touch with the essence of Section 83 and this filing.  This can lead equity recipients to false positives (seeking to file an 83(b) election where it’s irrelevant) and false negatives (not filing it where it is relevant), both of which are sub-optimal scenarios – with the false negative arguably being the more painful outcome.  Therefore, having a good grasp of the essentials of this tax filing and its relevance is important for issuers and recipients alike as they navigate the waters of equity compensation.

If you’re interested in this topic?  Would love to see you at our panel session at the NASPP Conference dedicated to 83(b) elections, on Tuesday, October 15!

Stepan Khzrtian is the co-founder and CEO of Corpora.us, which helps equity recipients file, track, and store their 83(b) election online.  Prior to Corpora, he practiced corporate law for over a decade, helping hundreds of founders navigate their legal journey across all stages of the company's growth, from incorporation to exit. He writes when he finds the time and has two cups of espresso a day – no more, no less.