83(b) election and early exercise: A guide for early employees

Founders and early startup employees often receive large equity grants in exchange for their work building a company. These grants, while potentially lucrative, come with complicated tax implications that can catch you off guard if you're unprepared.

What is an 83(b) election?

An 83(b) election gives individuals who receive unvested shares the option to recognize income at the time of transfer instead of at vesting. When made early — often when share value is low — it may reduce the amount of ordinary income recognized. Future appreciation, assuming holding period requirements are satisfied, is generally taxed as capital gain. Filing the election establishes the taxable value as of the transfer date.

What is early exercise?

Early exercise allows you to exercise stock options — typically incentive stock options (ISOs) — before they vest. Not all companies allow this, but it's becoming more common among startups looking to offer tax-advantaged compensation.

Here's how it works:

• You pay the strike price and receive shares that continue to vest.
• If you leave the company early, unvested shares are typically subject to repurchase/forfeiture.
• If you file an 83(b) election within 30 days of the early exercise, the shares are treated as received at transfer for income‑timing purposes, and your capital‑gains holding period on the shares begins then.

Why timing matters: Filing a Section 83(b) election generally starts the long‑term capital gains holding period at the time unvested shares are transferred. Without an 83(b) election, particularly for incentive stock options (ISOs), holding shares after exercise may result in an alternative minimum tax (AMT) adjustment as the stock value appreciates.

83(b) election and early exercise: A hypothetical scenario

Assume an employee can early exercise options for 100,000 shares at $0.10 per share. Years later, the company's value has risen to $10 per share.

With the 83(b)

The employee decides to early exercise and files an 83(b) election within 30 days. They pay $.10 cent per share on 100,000 shares that have since increased in value to $10 per share. Because the fair market value of the shares is the same as the price paid, no ordinary income is recognized at that time. The IRS considers the employee to have received the shares right away and the clock for long-term capital gain starts.

Without the 83(b)

Now imagine the employee didn't early exercise and file the election. When her shares vest a few years later, the company's value has risen to $10 per share. That means she would generally recognize ordinary income equal to the spread (≈$990,000).

When and how to file an 83(b) election

Timing is crucial. The IRS requires that you file an 83(b) election within 30 days of receiving unvested shares. There are no extensions. If you miss the deadline, the tax benefit is lost.

Here’s how to file an 83(b) election:

1. Fill out IRS Form 15620 (Section 83(b) Election).
2. Mail it to the IRS within 30 days (use certified mail to get proof of submission).
3. Keep a copy for your records.
4. Share a copy with your employer and consider attaching it to your annual tax return.

It's important to note that the IRS doesn't send a confirmation upon receipt. It's on you to track and document the filing.

Downsides and risks to consider

Though the tax benefits of early exercise and 83(b) are compelling, it does come with some risks:

• Upfront cost: You'll need to pay to exercise the shares and may recognize income before any liquidity.
• Forfeiture risk: If you leave the company early, you might lose unvested shares without getting the taxes that you already paid back.
• Stock devaluation: If the company's value drops after you file, you've paid tax and exercise cost on a higher valuation.
• No do-overs: The 83(b) election is irrevocable. Once you file, you can't change your mind.
• Alternative minimum tax: For incentive stock options (ISOs), you might trigger alternative minimum tax (AMT) depending on the spread between strike price and fair market value. Consult a tax advisor to assess the risk.
• Liquidity risk: Early exercised shares can't be sold until there's a liquidity event — such as a tender offer, secondary, or IPO — which may be years away.

Putting the 83(b) election in context

For founders and early employees, the 83(b) election is often discussed in connection with early exercise and equity planning. When considered alongside a company’s equity structure and timing, it can influence how equity awards are treated for federal tax purposes. Because the election must be made within a short window and requires accurate documentation, having a clear understanding of the process is essential.

When applied appropriately, this strategy may help you better manage future tax considerations and support long term planning around your equity. Consult a tax professional to evaluate how it aligns with your circumstances.

Planning with confidence

Equity compensation decisions, such as early exercise and the 83(b) election, can be important to long term planning. Citizens Private Bank can coordinate with you and your independent tax advisor as you consider how these choices fit into your overall financial goals. Request more information today.