Avoid This Big Tax Mistake When Founding Your Tech Startup
There are many tax planning techniques and optimizations to consider when dealing with equity compensation received from private and public companies, more than can be covered in one article. And it’s important to give this the attention it deserves: over your career, thorough tax planning on a regular basis can save you significant amounts of money and add to your net worth.
You can explore many of these considerations as part of a broader financial planning process, often with the guidance of a financial advisor, at various times in your company’s life. But when founding a tech startup company, there is one thing you should be aware of right from the beginning.
Filing an 83(b) Election
Let’s say you and a couple of friends or colleagues decide to start a company. You use Clerky or Cooley GO to incorporate your startup as a C corporation in Delaware. You issue stock to yourselves as founders, with some shares outright and some subject to a standard four-year vesting schedule. So far, so good. You’re on track.
The incorporation package includes something called an 83(b) election, but you don’t understand what that was all about, and you’re busy writing code, so you ignored it. That’s a mistake. That choice could cost you tens of thousands of dollars or more in extra tax if the company succeeds, depending on the company’s growth, vesting terms, holding period, and your individual tax situation.
The shares you receive outright are a form of compensation, and their value is taxable as ordinary income in the year you receive them. This isn’t a problem because the value of the shares is low. For example, if you receive 400,000 shares and the value of the shares is $0.00001 when you receive them, you owe tax at ordinary income tax rates on $4. No big deal.
Later, when you sell the shares, the increase in the value of the shares above $0.00001 will be taxed at the favorable federal long-term capital gains tax rate, assuming you hold the shares for at least one year.
The shares subject to vesting are also compensation income, and their value is taxable to you at the higher ordinary income tax rates. The difference is that the value of the shares becomes taxable to you as the shares vest, not when they are granted. This creates the problem.
For example, let’s say you were granted 2,000,000 shares subject to vesting. One year after the company was founded, the value of the stock is $0.10 per share, and 25% of your shares have vested. At that time, you owe ordinary income tax on $50,000 of compensation income. To make matters worse, because the company is still private, you won’t be able to sell any shares to raise cash to pay the tax. You’ll have to come up with the cash to pay the tax from other assets you own.
Let’s say in the following year, the value of the company is $0.50 per share, and another 25% of your stock has vested. At that point, you would owe ordinary income tax on another $250,000 of compensation income and still not be able to sell shares to pay the tax. You see the pattern. As the stock price rises each year and vesting continues, the problem grows.
Filing an 83(b) election solves this problem. With an 83(b) election, you are telling the Internal Revenue Service that you would like your shares that are subject to vesting to be treated as if they are all vested at the time the shares are granted.
In doing so, you agree to pay ordinary income tax on the shares you received based on the low price per share when they were granted, just as with the outright shares, and you avoid paying tax later as shares vest at higher share prices as the company grows.
In the example above, with the 83(b) election, you would owe ordinary income tax on $4 of income for the outright shares and $20 of income on the shares that are subject to vesting, for a total income of $24. The tax on $24 is negligible.
Going forward, all the gains in the shares, whether granted outright or subject to vesting, will be taxed at the lower long-term capital gains rates instead of the higher ordinary income tax rates, assuming you hold the shares for at least one year.
It’s also important to understand the risks involved. If shares subject to an 83(b) election do not ultimately vest or the company fails, taxes paid as a result of the election generally cannot be recovered, and any available loss deductions may be limited. As a result, an 83(b) election is not appropriate in all situations and should be evaluated carefully.
As of 2026, the highest federal tax rate on ordinary income is 37%, and the highest federal tax rate on long-term capital gains is 20%. The 17% difference between tax rates means that the tax savings from using an 83(b) election can be substantial in certain situations.
In addition to starting the one-year holding period to qualify for long-term capital gains treatment when you later sell your shares, the 83(b) election also starts the clock on the holding period required for the qualified small business stock (QSBS) exclusion, which can shelter some or all of the gain from federal income tax.
With QSBS, some or all the gain in the value of your shares may be excludable from federal income tax (and in some states, state income tax too). QSBS is another powerful reason to file an 83(b) election.
Why Timing Matters
The IRS has a dedicated form for making an 83(b) election (Form 15620, Section 83(b) Election) along with instructions, available on the IRS website. Alternatively, you can file a written statement that includes the required information under Treasury Regulation § 1.83-2. The election must be filed within 30 days of your shares being granted, and there are no exceptions for late filing. The incorporation package you use for your company’s founding documents may include instructions for filing your 83(b) election as well. Be sure to check with your tax advisor if you have any questions about how to properly file your 83(b) election.
There are hundreds of things to learn and details to process when founding a company. Being aware of this important detail (the 83(b) election) is an important place to start. Otherwise, you may jeopardize the financial results you’re working so hard to achieve before you even get started.
Savant Wealth Management provides holistic wealth management services including financial planning, equity compensation planning, investment management, tax planning, and others, on a fee-only basis and as a fiduciary, acting in clients’ best interests. If you’re thinking about hiring a wealth manager and would like to understand how ongoing tax planning can help you build net worth, schedule a complimentary consultation.
This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment or tax advice from Savant. Please consult your investment or tax professional regarding your unique situation.
Bruce R. Barton
Managing Partner / Financial Advisor
CFP®, CFA®, MBA