83(b) election – A Complete Guide for Companies
One way startups can save is by utilizing 83(b) election, a way to save on taxes and eliminate any other financial issues for their company.
After you’ve figured out how to allocate the company’s shares among the founders, it’s time to speak about the taxes you’ll have to pay on what you own. The IRC’s 83(b) option allows startup founders or employees to pay their taxes on the complete FMV (fair market value) of restricted shares at the award date. This 83(b) election applies exclusively to the stock that is subject to vesting.
83(b) election for companies
Many startups struggle at their early stages due to financial issues. As financial resources are scarce, it’s important for founders to save as much as they can and allocate the right amount of capital to what matters most for their business to grow. One way startups can save is by utilizing 83(b) election, a way to save on taxes and eliminate any other financial issues for their company.
What is an 83(b) election?
Under the Internal Revenue Code (IRC), 83(b) election is a provision that allows startup founders and employees the option to pay taxes based on the restricted stock’s total fair market value at the time of granting. This provision can save a startup and employees a lot of money and avoid any future tax difficulties when the 83(b) election is submitted within 30 days of receiving the restricted shares, as the possibility of forfeiture is eliminated.
How does 83(b) election work?
When you make an 83(b) election, you ask the IRS to record income and collect income taxes on the acquisition of business shares at the time they are awarded rather than when they vest. When an employee gets a company stock or stock options reward, it is known as the grant date. You can keep up with stock-based compensation along with your taxation plans.
Understand the tax strategy under 83(b) election
With restricted stock that is subject to a term of eligibility, such as a vesting schedule, there is a significant danger of forfeiture. After continuing to work for a certain amount of time or meeting certain performance goals, an employee’s stock usually vests. Vesting might take place over a single year or several. When an employee transfers his or her stock to a third party, the third party can get the shares on a fully vested basis. However, transferability is unusual in the absence of any significant danger of forfeiture. As a result, it’s critical to comprehend the vesting timetable.
Benefits of 83(b) election
If you hold shares for more than a year before selling them, you’ll benefit from lower long-term capital gains taxes. Filing an 83(b) allows you to begin the holding period clock early, straight after the grant date, allowing you to take advantage of the lower capital gains tax rate.
Because the restricted stock is awarded on a vesting schedule, the employee will have no taxable income on the date it is granted. Any dividends received by the employee as a result of owning restricted shares would be recognized as compensating dividends for tax purposes (i.e., ordinary income tax treatment subject to withholding).
Risks for filing 83(b) election
The amount of taxes incurred by the employee for failing to make an 83(b) election is directly tied to the value of the restricted shares during the vesting schedule (e.g., the more the appreciation, the more the tax cost for failing to make the election). The danger of leaving the company before the award vests must be carefully considered by the employee before choosing whether to make an 83(b) election.
Factors to consider when filing an 83(b) election
Identifying information about you (name, address, Social Security number). The property awarded (number and kind of shares of which firm), as well as the date received or purchased, any limitations on your shares, and the fair market value of the shares on the date received or acquired.
- Stock price – The word “stock price” refers to the current market price of a share of stock. When a publicly-traded company’s shares are issued, they are given a price — a value assignment that ideally represents the company’s worth.
- Risks – The probability of anything awful happening is known as risk. Uncertainty regarding the effects and implications of acting on something that humans value, with a concentration on negative, unwanted repercussions, is referred to as risk. There have been several definitions offered.
- Company policies – Employees’ behavior in the workplace is governed by internal corporate regulations. They also spell out what employees might anticipate from their boss. The corporate culture, the legislative environment, and the industry all have a role in determining which rules are required for a firm.
- Tax rate – When you exercise an incentive stock option, your employer is not obligated to withhold income tax because there is no tax owed (under the usual tax system) until you sell the stock.
- Existing concentrations – An 83(b) election permits the tax liability on the complete fair market value of the restricted shares at the time of granting to be paid in advance. Only if the restricted stock’s value rises in the coming years is it helpful. An 83(b) option may also be advantageous if the amount of income disclosed at the time of granting is minor.
Who should file an 83(b) election?
When you make an 83(b) election with regard to RS or options you receive, you decide to include the value of the RS or the spread of the options (the difference between the strike price, or the cost to exercise the option, and the fair market value at exercise, in your taxable income in the year you make the election, rather than when the RS vests or when you exercise your options after they have vested, when the value and resulting tax liability may increase) in your income rather than at that time.
- Stock option holders – Stock option holders can purchase or sell shares according to the terms of their contract, sell the entire option, or just let it expire. When stock options expire, they are worthless.
- Founders – A founder is a person who establishes their own business. They’re the ones who came up with the company concept and put it into action.
When to file 83(b) election?
If you have the opportunity to exercise your stock options before they vest, you can do so and file an 83(b) election within 30 days of doing so. In this manner, if the stock price of your firm rises, you may be able to reduce your future tax bill.
What happens when you make the election?
You probably want to take advantage of the 83(b) election and pay taxes before the restricted stock or stock options vest in order to reduce your taxes further. But, what exactly happens if you file the 83(b) election? Well, when you file an 83(b) election, you have the option to pay taxes at the time of grant rather than when you exercise. As such, you choose whether to include the value of the restricted stock or stock options in your taxable income at that particular time for tax purposes. However, if you don’t file your 83(b) election, you would be taxed for restricted stock or stock options at the time of exercising. To better understand the 83(b) election and its tax implications, let’s look at an example:
Steve is an employee of ABC Inc. and assumes that the company grants 10,000 shares of restricted stock at a price of $1 per share to Steve. While the shares will vest over four years in equal 25% installments. Now, Steve expects that the value of the share will increase over time, i.e, $5 after the first year, $10 after the second year, $15 after the third year and $20 after the fourth year. Considering all these facts, if Steve files an 83(b) election, Steve must include $10,000 of value at the time of the grant in his taxable income (10,000 shares*$1 per share). Further, in case Steve holds the shares for 366 days or more, he would pay capital gains tax instead of ordinary income tax. If Steve’s predictions of future stock prices are accurate, the value of the vesting shares at the first vesting date would be worth $12,500, $25,000 in the second year, $37,500 in the third year and $50,000 in the fourth year.
So, instead of paying ordinary income tax on $125,000 over the course of four years and long-term capital gains tax on $75,000 at the time of selling the shares in year four, Steve would pay ordinary income of $10,000 at the time of election and long-term capital gains tax of $190,000. This shows that Steve saves a lot of money if he makes the 83(b) election and, thereby, reduces his tax liability. Additionally, stock options work more or less similarly to restricted stock. However, the difference lies in the fact that with the stock option, the holder can control and decide when to file the 83(b) election. It is essential to note that under stock options, filing the 83(b) election is suggested as soon as the options are granted. Therefore, it is always wise to check with the tax advisor before you make the 83(b) election.
How to file 83(b) election?
Within 30 days of receiving your award, mail the completed letter to the IRS. Send a copy of your completed letter to your boss. Keep one copy of the completed and filed letter, as well as the proof of sending, for your records.
Example of 83(b) election form and what does it include?
Let’s say for example, a co-founder of a firm is given 1 million shares, which are subject to vesting and are worth $0.001 at the time of issuance. The shares are currently worth the par value of $0.001 x the number of shares, or $1,000, which the co-founder pays. The shares represent a 10% ownership stake in the company for the co-founder and will vest over a five-year period, meaning they will get 200,000 shares per year for the next five years. They will have to pay tax on the fair market value of the 200,000 shares vested in each of the five vested years.
FAQs on 83(b) Election
Here are some questions that are commonly asked about 83(b) election:
Why is it called the 83(b) election?
An employee or startup founder may decide to pay taxes on the entire fair market value of restricted shares at the time of grant by using the Internal Revenue Code’s (IRC) 83(b) election. Use the 83(b) election for shares of stock with a vesting term. The Internal Revenue Service (IRS) is instructed by the 83(b) option to tax the elector for stock ownership at the time of gift instead of when the stock vest.
What happens if you don’t make an 83(b) election?
A missed 83(b) election will impose a financial impact on the organization as well. At each vesting date, the corporation must settle on a valuation for freshly vested shares and appropriately report that amount as compensation. On the plus side, the corporation may usually deduct that sum from its profits.
Is 83(b) election for early exercise?
An 83(b) election permits you to calculate your tax obligation for an early-exercised option grant or acquisition based on the date of exercise rather than the day your shares vest and are exercised. It only applies if you earn stock as a consequence of exercising early options or receiving a restricted stock award (RSA).
Who can make an 83(b) election?
An employee or startup founder can opt under IRC 83(b) to pay taxes on the entire fair market value of restricted shares at the time of grant.
How long do you have to make an 83(b) election?
It is crucial to remember to file your 83(b) election within 30 days of receiving restricted stock or exercising your options early. If you don’t, your business shares will be taxed as ordinary income when they vest.
What happens when you don’t file an 83(b) election within 30 days?
An 83(b) election permits the tax liability on the complete fair market value of the restricted shares at the time of granting to be paid in advance. Only if the restricted stock’s value rises in the coming years is it helpful. An 83(b) option may also be advantageous if the amount of income disclosed at the time of granting is minor.
Can I file 83(b) elections electronically?
The IRS has begun accepting electronic 83(b) election filings. As a result, shareholders can utilize electronic signatures to sign their forms under Section 83(b) of the Internal Revenue Code. It’s a method for people to file 83(b) elections using their mobile devices.
Where do I file IRS form 83(b)
Within 30 days after your award date, mail the completed letter to the IRS. Send your tax return to the IRS Service Center where you filed it—the address for your IRS Service Center may be found here. Send the letter by certified mail and seek a return receipt if possible.
How can Eqvista help file an 83(b) election?
Overall, make sure you take into account all factors before filing for the 83(b) election. Consider how this decision would influence your income and capital gains tax on your shares, as well as what the company’s worth could be in the future. You can run for election if you are confident that the firm will grow. Check out the other knowledge-based articles or go to the main menu here to learn more!