Several years ago, after diagnosing what seemed like my one-thousandth patient with a preventable pregnancy complication and the realization that very few women were receiving recommended preconception testing which was leading to many of these complications, I decided to start a direct-to-consumer preconception testing service.
The direct-to-consumer idea had already been done with tests for fertility, sexually transmitted infections, and genetics, so preconception testing seemed like the natural next step. Unfortunately for me (and my business partner), I was trained in medicine and not business.
After a lot of research and some good fortune, PreConception Inc. was born (no pun intended). As most startups do, we incorporated as a Delaware C-Corp operating as a foreign entity in California. As one might expect, this process is accompanied by many legal documents, including a very important, yet often overlooked, IRS form called an 83(b) election. Luckily we used a service called Clerky that assisted us with the incorporation process and filing our 83(b) elections.
Company Incentives Through Common Stock
With a projected 20% annual growth rate for telemedicine, it’s likely that many of the physicians reading this will be approached to join a digital health startup at some point in the future, often with the incentive of compensation through company stock. For a physician joining the next Facebook, this can be an enticing offer, however, understanding the importance of an 83(b) election at the time that company stock is issued is critical to minimize your future tax burden.
The first thing to know about startup stock is that it will usually fall into one of two main classes — common stock and preferred stock.
Preferred Stock
Preferred stock is provided to investors.
Common Stock
Common stock is typically issued to founders, advisors, employees, etc. Common stock subjected to a vesting schedule is referred to as restricted stock.
Restricted Stock Vesting Schedule
The most common vesting schedule for startups is a 4-year vesting schedule with a 1-year cliff. This means that 1/4 of your shares will vest at the one-year anniversary of stock issuance, with 1/48th of the total original shares vesting every month thereafter until your shares are fully vested at 4 years. This vesting schedule protects the company should you leave before one year and rewards you for your time during an early stage of the startup when growth is often rapid.
Tax Problems with Vesting Schedules
This brings us to the importance of an 83(b) election. When shares are subject to a vesting schedule, the IRS considers each vesting period to be a taxable event. For individuals with a 4-year vesting schedule as described above, this means that after the first year, a taxable event occurs every month.
For the purpose of taxation, the IRS considers the difference between the fair market value of the shares at the time that vesting occurs and the price you purchased the shares for (which for early startups can be as low as $0.0001/share) to be taxable income, even though you're not typically receiving any actual money from the vesting of your stocks.
This can cause two problems for individuals with restricted stock:
- It can be extremely difficult to pay a large tax bill when your shares are from a fast-growing company with a high valuation that is not yet providing significant income to you (as is the case for many startups) and
- You (or your accountant) will need to perform this calculation every single month for 3 years.
The Critical 83(b) Election Solution
In an attempt to simplify this process, the IRS allows recipients of restricted stock to make an 83(b) election for “alternative tax treatment”. This makes the purchase of the stock (at the $0.0001 price, in this example) to be the only taxable event, allowing you to avoid paying tax on the increased value of your stocks over your vesting period.
The really critical component of this process, however, is that you only have 30 days from the date of stock issuance to manually sign the 83(b) election form, mail it to the appropriate IRS office (this varies by state), and provide a copy to your company. If you miss this deadline, there is no easy way to correct it and you're likely stuck with the standard vesting tax structure as described above.
Kristy Goodman, Co-Founder and CEO of PreConception Inc.
Because this process is time-sensitive and has long-reaching implications, Clerky recommends the following:
- Mail your 83(b) election to the IRS using USPS certified mail with a request for a return receipt
- Keep the certified mail receipt and the return receipt in your records
- Include a copy of your 83(b) election form, a self-addressed, stamped envelope, and a letter requesting acknowledgment of receipt. The IRS will usually stamp your copy of the 83(b) election and mail it back to you.
Like most of us, startup founders are typically not experts on tax law and therefore may not have a great understanding of this process themselves. If you’re receiving company stock as compensation, my suggestion is to not rely on the company’s founders or HR person to educate you on these nuances. Rather, ask questions and do your due diligence before accepting any form of company stock.
Have you received company stock as part of your compensation? How did you learn about the 83(b) election? Comment below!
Another possible problem (which I’m pretty sure happened to a former neighbor of mine who was an exec for a small internet startup in the ’90s) would be that you end up paying taxes on shares with increasing value as they are vested, but you are not yet able to sell them and realize the capital gain income. You can get screwed if you end up paying a lot of tax on rapidly appreciating shares but never end up being able to realize the gain if the company ends up going bust before you are permitted to sell any of them.
Definitely a risk.
Very timely info as I am getting these stock options later this year and for the next 36 months… I definitely want to look into this process more. thank you!!!
Glad to hear this will be helpful!
I was completely unaware of the 83(b) issue, so thanks for this post. I’m a US physician who consults for a privately-held company based outside the US. The company encourages all employees and consultants to take as much of their salary in company “stock” as possible. I take the majority of my fee in actual money and receive a minority of my fee as fully-vested shares in the company.
When it comes time for a distribution of company shares, I am asked to send a small check for the “current value” of the shares, and then that money I paid is paid back to me in my next compensation check, making the shares essentially free. But of course, I have sacrificed a small portion of my hourly fee to get those shares, so they’re not really free.
I thought I was being a good citizen by declaring to the IRS the cash income I’ve received from this company (they don’t issue a 1099). But now I wonder if I should be declaring the company stock as well? If anyone has insight into this, it would be much appreciated (I use TurboTax and do not have a tax advisor or accountant).
Interesting article. A deep dive on the implications of a ‘missed 83(b)’ election can be found here:
https://www.etonvs.com/single-post/2016/09/28/Missed-83b-Election-Deadline-A-Potential-Remedies
As a perinatologist, I am not excited to see on online company hawking a ‘preconception test’ which is little more than an ‘educational online call’ and a set of prenatal labs without genetic tests for $299. I note the company carefully words their call to not include anything to resemble ‘medical advice’ thus skirting law around the practice of medicine outside of licensure (Goodman is a PA in California). The real value of the preconception visit is the screening for potential high risk issues — yes, baseline labs may be part of that — but a health history and a thorough discussion of genetic/carrier screening are more important. There is likely also a benefit in meeting and screening a potential OB care provider in the course of the visit and having some assurances for follow up in the event of subfertility/infertility issues. Kristy Goodman’s business model is unfortunately reductive of the patient experience. Look how little time is spent in the ACOG guidance on labs and how much effort is spent onscreening and counseling:
https://www.acog.org/clinical/clinical-guidance/committee-opinion/articles/2019/01/prepregnancy-counseling
I wish Ms Goodman luck in her future business endeavours but I hope her patients (clients?) save the $299 for their future kids’ 529.
Thank you for reading the article and reviewing our website. As a perinatologist I’m sure you’re aware of how few women actually receive preconception care in the U.S. and the significant implications of that despite guidelines supporting this for every woman planning a pregnancy. Our company is merely a starting point to introduce the idea of preconception care and testing as survey’s demonstrate only 1/3 of women ever receive any information on preconception care from their providers. We certainly never claim to be a full scope preconception service although preconception testing is absolutely a basic component of preconception care, there is no “may be” about this.
Our hope is that this information will empower women to start the conversation with their providers and advocate for a more thorough discussion from the significant number of providers who dismiss women’s questions with nothing more than a recommendation to start a prenatal vitamin. We’ll be expanding our services in the future to offer additional testing (we already offer the genetic testing you’ve brought up) as well as full scope consultations as I agree that the tests are just one piece of the puzzle. If you do actually have a passion for expanding access to preconception care as we do, I’d hope you would consider joining our network in the future.
Great article! This is a very informative overview of the 83(b) election under the federal tax code, a critical mechanism for individuals receiving restricted stock, or stock options that vest over more than the current tax year. By opting for an 83(b) election, recipients can significantly mitigate their tax burden by paying income tax based on the stock’s initial value rather than its value at vesting, potentially saving thousands in taxes as the company grows. However, the article also rightly points out the risks involved, such as the possibility of paying taxes on stock that may never vest or lose value. For those contemplating the 83(b) election, understanding the full implications of a missed 83(b) election deadline is also crucial. A deep dive on the implications of a ‘missed 83(b)’ election, along with potential remedies, can be found at https://etonvs.com/409a-valuation/missed-83b-deadline-remedies/. This additional resource is invaluable for navigating the complexities of tax planning with restricted stock.