Tax Strategies for Non-Taxable Stocks

For founders, employees, and directors with stock-based compensation, an 83(b) election can be a powerful tax planning tool. When you make an 83(b) election, you choose to pay tax on unvested shares now, rather than when the shares are paid out. Most tax planning strategies focus on deferring tax, but an 83(b) election is all about accelerating it.

Why Make an 83(b) Election? The key reasons to consider an 83(b) election are to minimize your taxable income and control the timing of your election. If you have stock options, founders’ shares, or restricted stock, here’s what you need to know about making an 83(b) election for non-ownership stock.

What is an 83(b) election?

Section 83(b) of the Internal Revenue Code provides individuals with the ability to accelerate the taxation of their equity grants. Typically, equity-based compensation is subject to vesting requirements: timing, performance, liquidity events, possibly a number of factors. With the default tax treatment, there are no tax implications at the time of grant because the taxpayer risks losing the shares until they vest (or are exercised in the case of options). In tax jargon, this is called significant risk of forfeiture.

But there are some cases in which it pays the taxpayer to recognize this income now—before the shares vest. This can be accomplished by making an 83(b) election. For restricted stock, this means paying tax on the taxable spread at the time of grant, not when the shares vest. If you have stock options, an 83(b) election can be made in conjunction with an early exercise.

In either case, the difference between the exercise (or purchase) price and the current fair market value of the stock is taxable, either as ordinary income (in the case of restricted stock and nonqualified stock options) or as alternative minimum taxation (AMT) (in the case of incentive stock options). By making the election, any subsequent taxation is deferred until the stock is sold.

Who can make an 83(b) election and what type of stock compensation is offered?

Startup founders, early employees, executives, and other service providers can make an 83(b) election. For stock option holders, the company must allow early exercise.

Here are the types of unissued shares that are eligible for selection (assuming the shares have not yet been issued):

• Restricted Stocks (Unrestricted Stocks) units)
• Founder shares (this is not a legal term and usually refers to ordinary shares)
• Incentive stock options
• Non-qualified stock options
• Gains from LLC or Partnership Shares

Key terms:For restricted stocks, the 83(b) election must be stamped and mailed to the IRS within 30 days of the date grant or spread will be subject to regular income tax at the time of vesting. In the case of stock options, the application deadline is 30 days from exercises.

3 Major Benefits of 83(b) Elections

Under the right circumstances, the 83(b) election can be a very effective tax planning tool.

1. Possibility of minimizing tax

As illustrated in the examples below, making an 83(b) election can dramatically reduce your tax bill in certain circumstances. An 83(b) election is typically most beneficial if it accelerates income when the taxable spread is zero or close to zero. Early-stage startup stocks will typically be very, very cheaply valued, making this tax strategy possible. Assuming the holding periods are met (more on this below), it may be possible to completely shift your taxable income to more favorable long-term rates by making an 83(b) election.

2. The tax-advantaged asset holding period begins

The election begins the countdown to several key holding periods:

3. Greater control over tax position and equity

Another benefit of making an 83(b) election is that you have more control over your tax situation. Before making this election, consult with your tax and financial advisor to understand the impact on your tax situation and make an informed decision.

Making the election can help avoid cash flow and tax problems for years to come. Without the election, restricted stock grants and early exercised stock options will have tax consequences whenever the shares vest, because the difference between the future fair market value of the shares (less the purchase/exercise price) is subject to regular income tax (this is AMT income for ISOs). For fast-growing startups, this can be a big headache, especially when there is no public stock market.

For employees with stock options, making an 83(b) election can be important later if valuations rise. The wide spread makes it very difficult financially to exercise the shares before the options expire after you leave the company. It can also prevent some tax planning strategies down the road.

Tax rules change periodically and are set to change again in 2026. The acceleration of taxation of stock-based compensation could mean that more favorable tax rules are here to stay. At the very least, it means that taxpayers are less affected by financial problems beyond their control.

Considerations before making a selection 83(b)

Like everything in personal finance, 83(b) elections aren’t always obvious. Here are some things to keep in mind.

• Stocks may not go upThe risk of making an 83(b) election increases with the cost of buying the stock and/or the taxable spread because you have more cash on the line. There is the risk of overpaying taxes if the valuation does not increase or if the company does not succeed.
• Your shares still need to be grandfathered. An 83(b) election is irrevocable. Make sure you are happy with the vesting requirements.
• The holding period is not guaranteedRegardless of how long you want to hold shares, they may be affected by merger and acquisition activity, repurchase rights and other events.
• Cash demand. Depending on the strike price and valuation, early exercise can still be cash intensive. Make sure it makes sense for your financial situation and goals.

Simplified Hypothetical Example: Early Exercise of Nonqualified Stock Options with an 83(b) Election

For simplicity, the example below does not include employment taxes or state tax implications.

• Strike price = $0.1
• Current quote = $0.1

Ordinary income on early exercise = $0. After one year, assume the shares have vested and can be sold for $6/share. Long-term capital gain = $5.90/share.

Making the election resulted in no regular income and all the gain being shifted to long-term capital gains. The top tax rate on long-term capital gains is currently 20%.

Without the election, and assuming it occurs sooner, the employee would have ordinary income of $5.90/share at vesting time, regardless of whether he or she sold the shares. The top income tax rate is currently 37%.

Planning notes:

• Now let’s assume in the above example that the option was exercised after vesting. In this case, the ordinary income would be the same (assuming no change in valuation), but the employee would control the timing. So it is usually best to exercise the option early with an 83(b) election or consider delaying exercise.
• The tax treatment in the above example is very similar for restricted stock. However, restricted stock does not have the flexibility that stock options have in controlling the exercise date.
• Incentive stock options must be held for at least two years from the date of grant and one year from vesting to take advantage of long-term capital gains taxation. For executives who have the ability to negotiate equity compensation, other forms of stock compensation may be more beneficial depending on your goals.

Long-term planning with stock-based compensation

If you’re a founder, or if stock compensation is a significant part of your compensation package, it pays to think long-term and strategically. Especially for startup employees, early tax and financial moves are often the most important in generating wealth.

But it’s equally important to be realistic about each company’s time horizon, risks, and prospects. The decision to make an 83(b) election is just one piece of a complex puzzle that should be considered and discussed with your personal financial and tax advisors.