For Doctors Joining a Startup: You Gotta Know This Rule
Miss the §83(b) election and you could get taxed bigly
Are you a doctor who plans to work for a startup and receive restricted stock as part of compensation?
If yes, this is for you.
You must understand the IRC §83(b) election.
In the right situation, it can save you a massive amount in taxes.
In the wrong situation, it can cost you dearly.
Let’s start with the general rule.
The General Rule: Compensation is Taxable.
Under the general income tax rule in IRC §61, if you provide services to a company and receive compensation, including company stock, the IRS treats that stock as compensation income. In short, you pay tax on it.
If you’re a medical executive and receive stock for your services, that stock is income equal to its fair market value.
However, IRC §83(a) creates an important exception to this general rule.
IRC §83(a): Substantial Risk of Forfeiture
If you are required to give the stock back to the company unless you stay employed for a substantial period of time, typically two years or more, the stock is considered to be subject to a “substantial risk of forfeiture.”
As long as that risk exists, you do not have to report income yet.
You report income only when the substantial risk of forfeiture goes away. That is when the stock vests and truly becomes yours. At that point, you report compensation income equal to the fair market value of the stock at vesting.
Let’s look at an example.
On 1/1/22, Dr. Startup joins Kimchi Medical, Inc. as CEO and receives 1,000 shares of restricted stock worth $100 per share, for a total value of $100,000.
The employment agreement requires him to stay with the company for two years. If he leaves early, he must give all 1,000 shares back.
Because there is a substantial risk of forfeiture, Dr. Startup reports zero income in 2022. Even though the stock is worth $100,000, no tax is due because it can still be taken away.
That feels fair.
The First-World Problem: The Stock Moonshots
What if the company takes off?
Assume that on 1/1/24, when the two-year requirement is satisfied and the substantial risk of forfeiture disappears, the stock is now worth $1,000 per share (up from $100 per share).
Dr. Startup must then report in 2024:
$1,000 × 1,000 shares = $1M of ordinary income
Instead of being taxed on $100k in 2022, he is now taxed on $1M.
This is a first-world problem, but it’s still a tax problem. And this is exactly where the §83(b) election comes in to rescue, like Captain Underpants.
What is the §83(b) Election?
The §83(b) election allows you to accelerate income recognition. This is the opposite of most tax strategies, which focus on deferring income, such as 401(k) contributions.
By making the election, you are telling the IRS:
“I know I could lose these shares, but I’m willing to take that risk and pay tax now on the current value.”
Here is the critical rule rule:
You must make the §83(b) election within 30 days of receiving the restricted stock.
Not 30 days after vesting.
Not 30 days after you realize the stock is valuable.
Thirty days after the grant (here, 1/1/22).
Miss that window, and the election is gone forever.
Applying §83(b) to Dr. Startup
If Dr. Startup made a §83(b) election on 1/1/22, he would include $100,000 of compensation income in 2022.
Assume he is in the 37% tax bracket.
Tax paid in 2022:
$100,000 × 37% = $37,000
Two years later, on 1/1/24, the stock vests and is worth $1,000 per share, or $1,000,000 total.
At vesting, there is no additional compensation income. He already paid tax.
If he sells the shares at that time, his capital gain is:
$1,000,000 − $100,000 basis = $900,000 capital gain
Assume a 20% long-term capital gains rate.
Capital gains tax:
$900,000 × 20% = $180,000
Total tax with §83(b):
$37,000 (in 2022) + $180,000 (in 2024) = $217,000
Without the §83(b) Election
If Dr. Startup did not make the election, he reports $1,000,000 of ordinary income at vesting in 2024.
Tax at 37%:
$1,000,000 × 37% = $370,000
The Difference
With §83(b): $217,000 total tax
Without §83(b): $370,000 total taxTax savings: $153,000
Effectively, Dr. Startup converted $900,000 of ordinary income into capital gain.
That is the power of §83(b).
The Risk: No Free Lunch.
There is real risk here. An §83(b) election is a gamble.
If the company fails, the stock becomes worthless, or Dr. Startup leaves before vesting, he does not get his tax money back. In effect, he paid tax on income he never economically received.
That $37,000 paid in 2022 is gone.
This is why §83(b) elections tend to make sense only when:
The stock value is very low at grant
The upside is very large
You expect to stay long enough to vest
You can afford the tax cost if things go badly
Final Thoughts
If you are a doctor joining a startup and restricted stock is part of the offer, §83(b) is not optional knowledge. It is a critical planning decision with massive upside and real downside.
This is not something to figure out when you settle into the new job.
By then, the 30-day clock may already have run out.
If you’re joining a startup, learn this before day one.