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There are very few “gotcha’s!” left in corporate law. Most mistakes, however bad, can be fixed. It might be a hassle, and cost a lot more, but it seems there are almost no good faith errors that can’t be remedied. That’s because the law, despite what many may believe, does usually try to be fair. And it does not get much more unfair than punishing someone for a genuine mistake to the point where that mistake is truly irredeemable. Not only is that unfair, but (we have learned) it’s bad for business. A modern corporate law regime is meant to be predictable and fair. That promotes efficiency, which is good business, if a bit boring when compared with the much harsher days of old when business law was not to be messed with. A delinquent debtor in 2023 may bemoan his garnishing order, but at least he isn’t doing so from debtors’ prison. That’s what makes a missed 83(b) election so harsh and, if only for being so old-school, weirdly fun (in a purely academic sense). So, what is an 83(b) election, and what are the consequences for missing it? To start with the second question, as you may have guessed, the consequence is harsh (i.e. irredeemable). If you fail to timely make an 83(b) election within 30 days from the issuance of the underlying securities, there’s no fixing it. No backup plan. Forevermore, the IRS will treat your share issuance as subject to regular tax treatment. That hints at the answer to the first part of the question. What is an 83(b) election? It’s a submission you make to the IRS when you first receive securities that are subject to vesting. By making the submission, you are asking the IRS to tax you now, on the current value of the securities. Why the hell would anyone choose to be taxed now? Because the idea is that the value of your securities will go up. And in most cases, the current value is so low, it almost definitely will. The alternative would be to get taxed as the securities vest at ever-increasing valuations. To illustrate, it’s helpful to look at one of the most common scenarios where an 83(b) election is filed. Two founders start a company together. They like each other, and believe they will work well together, but they don’t like, know know each other. So, they agree their initial founder shares will be subject to vesting. That way, if one of them turns out to be do all the work, while the other styles himself more the “ideaz guy”, the worker can part ways with the pontificator and his ownership will only be watered down by the amount of shares that the “ideaz guy” has actually vested into at the time they split. Now, when they first set up their company, it was literally only worth the paper it was written on, so the value of their initial shares would be set at some impossibly low number like $0.00001 (that’s par value). By making a (timely!) 83(b) election, each founder is electing to be taxed at that current (super low) value, and not at whatever value the shares may be as they vest. A digression for the legal nerds: So why does the IRS allow us this seemingly to-good-to-be-true “get out of paying your taxes” card? Well, there’s a technical reason and (probably) some kind a policy reason too. The technical reason is that, according to the tax code, you cannot be taxed on any asset that remains “subject to a substantial risk of forfeiture”. If a security is subject to vesting, the whole idea is that you may not eventually get that security. There are conditions attached. Hence, it is under risk (and probably a substantial risk) of being forfeited. So, by making an 83(b) election you are, technically, making an election against your interest. You are choosing to be taxed on something you may not own. And the IRS requires that you specifically choose to do that (hence the election). I did mention the law is basically fair, right? You also mentioned a policy reason? Well, for anyone who knows anything about tax law, it’s all about policy. Taxes are a big deal everywhere, but especially in America, which was basically founded over a tax dispute. This is just conjecture, but it’s my strong suspicion that the IRS and tax legislators are well-aware of the lucrative “gap” in its tax net, but, like QSBS, they allow it in this case as an incentive to entrepreneurship. But something about missing out on potential tax revenue must just go too far against some deeply-imbedded grain at the IRS, hence why (I believe) they decided to employ a 30-day, one shot one opportunity, cold as ice election period. Quite badass.

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