Filing an 83(b) election allows people to pay taxes now, in hopes that a company will be successful and stock value will appreciate. If that happens, tax liability is much more manageable, saving lots of money. Instead of being taxed at the ordinary income tax rate, any additional gain will be taxed at the lower long-term capital gains rate.
A Guide to Section 83(b) Election for Startup Founders
For startup founders, Section 83(b) elections are certainly a topic of interest. Business founders have likely heard they should file an 83(b) election, but what exactly is this, when should you file it, and is it mandatory? We’re here to demystify the details of the 83(b) election, including how it’s filed and the process of filing.
What is an 83(b) Election?
An 83(b) election is a provision under the internal revenue code or IRC. It is filed to indicate that an elector would like their equity, typically shares of restricted stock, to be taxed at the time it is granted at its fair market value. Under 83(b) elections, the value of the entire stock is included in an individual’s gross income in the year of receipt.
The election gives startup founders and employees the option to pay taxes on their options, before they vest. It’s called an election because founders are electing, or choosing, to pay taxes early.
When do you use an 83(b) election?
For startup founders and early stage employees of the startup, it makes sense to complete an 83(b) election upon receipt of unvested shares. That is when the stock value is generally low, so the taxes will not be high.
How long do you have to make an 83(b) election?
An 83(b) election must be filed with the IRS within 30 days of the exercise. The election has to be made upon receipt of the actual shares of the stock, and not the option. Exercise first, election next.
If eligible individuals receive an early exercisable stock option, the 83(b) election can be made upon receipt of the exercised shares.
What if you forget to fill out an 83(b) election?
If individuals do not meet the 30-day deadline for an 83(b) election, though limited, there may still be options. However, it is important to know, there is no way to extend that time period.
For new startups, consider cancelling the old stock grant and issuing a new one, or creating a new grant with a different vesting schedule or number of shares. It’s also possible to amend a stock grant so that the repurchase price is at fair market value.
Most commonly, the employee must recognize the stock value as income as they satisfy the vesting conditions. Unfortunately, this often happens at a time when it has appreciated in which the amount of taxable income has also increased along with it.
It is important to seek financial and legal advice before proceeding with these options.
Are 83(b)s required if you have no vesting?
Elections do not apply to vested shares, only to stock that is not yet vested. Any stock that is not early exercisable will not qualify for 83(b).
According to the IRS, if vesting restrictions are imposed on previously purchased fully vested stock, stock is treated like it was purchased at the time of original purchase. Anything that is taxable as income is measured at the time of the original purchase of shares, so there is no need to file an election.
If you are the sole founder/equity holder, you should only file an 83(b) election if the equity is subject to vesting. You do not need to make an 83(b) election when there are no restrictions on your ability to dispose of the stock. If for some reason the shares are subject to vesting, you should then consider filing an election.
How is a section 83(b) election made?
An 83(b) election is made through filing with the IRS. Make three copies of the signed and completed election form and one copy of the IRS cover letter. You will send the original form and letter, a copy of the cover letter, and a self-addressed stamped envelope to the IRS.
The center to send it to is the one where you would normally file your tax return. Sending the paperwork via certified mail is highly recommended.
Deliver a copy of the election form to the company. You may need to attach another copy to your income tax returns depending on your location. Keep another copy for your own records.
Who Uses an 83(b) Election?
Who files an 83(b) election?
The person who receives restricted stock in compensation for their work, in other words the taxpayer, is the one who files the 83(b) election for themselves.
Should founders file an 83(b) election?
In most cases it’s a good idea for startup founders to make an 83(b) election. The stock value is usually low at the time it is purchased, which offers the potential for tax savings in the long-run.
Can a partnership make an 83(b) election?
Each taxpayer must complete his or her own 83(b) election.
Does a preferred stock investor need to file an 83(b) election?
For a preferred stock investor, the situation is generally different. Preferred stock typically comes with predetermined dividends and doesn’t have the same vesting requirements as restricted stock or stock options given to employees. Since preferred stock usually isn’t subject to the same type of vesting schedule—where ownership rights are contingent on continued employment or meeting performance milestones—the conditions under which an 83(b) election is relevant don’t usually apply.
In essence, since preferred stock is often fully owned at the time of purchase and isn’t earned based on service or performance criteria, there’s no need to make an 83(b) election. This election is primarily for situations with a risk of forfeiture associated with vesting conditions, which isn’t typically a concern for preferred stock investors. Therefore, preferred stock investors generally do not need to file an 83(b) election.
Can you use online tax platforms to file an 83(b) election?
Yes, you can use online tax platforms to file an 83(b) election, but it’s important to ensure you do it correctly since the process is a bit specific. Section 83(b) elections are not filed with your regular tax return at tax time. Instead, they must be filed with the IRS within 30 days of receiving the restricted stock or stock options. This election involves sending a letter to the IRS, indicating your choice to be taxed on the fair market value of the shares at the time they were granted, rather than when they vest.
What Should You Consider Before Doing an 83(b) Election?
What are the benefits of an 83(b) election?
What are the risks of an 83(b) election?
The biggest risk is that share value may not appreciate, or may even depreciate. In the case of depreciation, because taxes are prepaid on a higher valuation of equity, individuals will have unnecessarily overpaid in taxes. This overpayment of taxes cannot be claimed.
An 83(b) election might also keep an employee around longer than they would like, waiting to see stock options, and not wanting to have paid taxes on shares they will never receive.
What happens if a founder does not file an 83(b) election?
Not opting in with an 83(b) election means founders will incur tax liability on the value of vested shares, as they vest. If founders sell vested stock, the difference between the sale price and fair market value is treated as capital gain.
What are the Steps to Filing an 83(b) Election?
What is the best way to fill out an 83(b) form?
Be sure to carefully read over the form and fill in all applicable areas. A financial and/or legal advisor can be extremely helpful in ensuring the form is completed correctly.
How to report income from an 83(b) election
Depending on your state of residence you may need to file a copy of the 83(b) election with your income tax return. However, in most cases the fair market value is already included in other forms like W-2, box 1 or 1099-MISC, box 7.
Does 83(b) election need to be attached to 1040?
Your 83(b) election form no longer needs to be attached to your form 1040.
Does your spouse need to sign 83(b) election?
Generally, a spouse only needs to sign the 83(b) election form if residing in a community property state.
Where do you send an 83(b) election?
Your 83(b) election form should be sent to the IRS center where you would normally file your income taxes. Information on this can be found on the official IRS website.
How do I know if the IRS received my 83(b) election?
It is strongly recommended to send your 83(b) form as certified mail requesting a return receipt. By including a self-addressed stamped envelope and a request that the IRS return forms with a date stamp, you can ideally confirm receipt.
Update: the Internal Revenue Service has announced that it would temporarily allow Section 83(b) elections to be signed digitally or electronically (through October 31, 2023).
When is it detrimental to file an 83(b) Election?
Filing an 83(b) election can be a powerful tool for those who receive restricted stock units (RSUs) or other forms of equity compensation, but there are situations where it could be detrimental. Here are some scenarios in which filing an 83(b) election might not be the best choice:
Uncertain Future Value: If you’re unsure about the future value of the company’s stock, filing an 83(b) election might not be wise. By making this election, you’re essentially prepaying taxes based on the stock’s current value. If the stock value doesn’t increase as expected or even decreases, you’ll have paid unnecessary taxes.
Immediate Tax Burden: When you file an 83(b) election, you’re required to pay taxes on the stock’s fair market value at the time of the grant, even if it’s not yet vested. This can create a significant tax burden that you might struggle to cover if you’re short on cash.
Short-Term Employment: If you’re not planning to stay with the company for the vesting period, filing an 83(b) election might not make sense. You’ll be paying taxes on stock that you may never fully own, potentially losing out on valuable tax benefits.
Lack of Funds: Paying the taxes associated with an 83(b) election can be challenging if you don’t have the cash available. Using your own funds to cover the tax bill may not be practical, and you might end up having to sell some of the stock to cover the tax liability, defeating the purpose of the election.
Complex Tax Situation: If you have a complex tax situation or are not well-versed in tax matters, it’s essential to consult with a tax professional before making an 83(b) election. Filing it incorrectly or without a full understanding of the implications can lead to costly mistakes.
Conclusion
In conclusion, understanding the intricacies of the Section 83(b) election is paramount for startup founders navigating the world of equity compensation. This guide has shed light on the importance, benefits, and potential drawbacks of making this election. As a founder, the decision to file for an 83(b) election should align with your unique financial situation, long-term commitment to the company, and future growth projections. It’s a powerful tool that, when used wisely, can help you optimize your tax strategy and unlock the full potential of your equity awards. Remember, seeking professional advice and carefully weighing the pros and cons are essential steps on your journey toward building a successful startup and securing your financial future. Reach out to Finvisor today, we’re ready to help!
- Last Modified
- April 26, 2024
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