Election 83(b) for Startups: Overview and Benefits

by Sarath | July 19, 2022 | 83(b) Election , Restricted Stock

A person, such as a startup founder or employee, might opt to include the fair market value of property connected to the performance of services as income under section 83 (b). The election simply permits a person to choose to be taxed when the property is received rather than when it is completely vested. In this article, we will discuss the importance of election 83(b) for startups and the benefits of filing it.

Election 83(b) for startups

For startups, a Section 83(b) election can allow startup founders who receive restricted stocks to save on taxes because the tax is based on their fair market value (FMV) of when the stock is granted rather than the FMV of when it vests. Startups can avoid future tax problems by filing the 83(b) election.

What is Election 83(b)?

The Internal Revenue Code’s (IRC) 83(b) election allows an employee or startup founder to pay taxes on the complete fair market value of restricted shares at the time of grant. The 83(b) election is for equities that have a vesting period. The 83 (b) election instructs the Internal Revenue Service (IRS) to tax the elector for stock ownership at the time of gift rather than when the stock vests.

How does Election 83(b) work?

Making an 83(b) choice allows you to pay income taxes sooner, typically before your company’s shares have had a chance to rise in value. If and when you sell shares for a profit in the future, you’ll just have to pay capital gains taxes rather than ordinary income taxes, which are greater. If you hold shares for more than a year before selling them, you’ll benefit from lower long-term capital gains taxes.

Why should the startup file for Election 83(b)?

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. It raises your regular income tax rate. Please keep in mind that Section 83(b) elections only apply to stock that is subject to vesting, since fully vested stock awards are taxed at the time of issuance.

Where is Election 83(b) considered useful and who can file it?

A Section 83(b) election is made by writing to the IRS and requesting that the restricted stock be taxed on the day it was issued or bought rather than the planned vesting dates.

A missed 83(b) election will impose a financial impact on the organization as well. The corporation must settle on a valuation for freshly vested shares at each vesting date and appropriately report that amount as compensation. On the plus side, the corporation may usually deduct that sum from its profits.

Are there any risks involved with Election 83(b)?

Making an 83(b) election raises the risk since you will have paid taxes on income that you will not get until the vesting period ends. Furthermore, it’s conceivable that the stock price may not rise, resulting in your paying taxes early and gaining no further advantages. When a firm’s founder or other employee obtains stock or another equity that is subject to vesting, that is, conditions may necessitate the stock to be lost, such as if the founder or other employee leaves working for the company — the Sec. 83(b) election is frequently made.

Filling Election 83(b)

A Section 83(b) election is a one-page document that you send to the IRS to inform them that you want to be taxed on property subject to a “substantial risk of forfeiture” (more on this below) that you get in return for services when you receive it rather than when it vests.

When should startups consider filing for Election 83(b)?

A Section 83 (b) election can save a startup firm founder who receives restricted stock a lot of money in taxes since the tax is calculated on the property’s fair market value when it is given, not on the fair market value when it vests. You can also avoid future tax difficulties by submitting the 83 (b) election within 30 days of receiving the restricted shares, as the possibility of forfeiture is eliminated.

Important considerations when filing for Election 83(b)

Before filing Election 83(b), there are some important factors to consider that every startup founder needs to take note of:

Election 83(b) can help to lessen your individual tax burden
If they did not make an 83(b) election and the shares vested, the IRS will force them to pay taxes on the difference between the current value of the vested shares and the price they paid for them originally.
Founders may have a higher tax burden if the firm has grown significantly over the course of a year or more and they did not pay anything for those shares.
If an 83(b) election was made and the shares finally vest, the founder may owe nothing or may owe a significant amount.

What if startups don’t file for Election 83(b)?

If you work with an attorney, they may complete this for you, and all you have to do is sign and mail it in. To make an 83(b) election, you must send a letter to the IRS office, where you file your returns by certified mail. Request a return receipt, which you should save alongside the letter you submitted to the government agency for your records.

Examples of 83(b) election

To offer some basic tax background, there are several sorts of tax rates. In 2020, the maximum conventional income tax rate will be 37%, while the maximum long-term capital gains rate will be 20%. Because the United States utilizes graduated tax rates (meaning the rates change depending on your income), you may actually pay lower rates, but the long-term capital gains rate will always be lower than the regular income tax rate.

If no Section 83(b) election is submitted, you will be taxed on the value of your restricted stock as calculated at grant (if a Section 83(b) election is filed) or upon vesting (if no Section 83(b) election is filed), at the appropriate ordinary income tax rate in each case.

Steps to follow while filling for 83(b) election

If you work with an attorney, they may complete this for you, and all you have to do is sign and mail it in. To make an 83(b) election, you must send a letter to the IRS office, where you file your returns by certified mail. Request a return receipt, which you should save alongside the letter you submitted to the government agency for your records.

Fill out the 83 (b) election form – Your name, address, taxpayer identification number, a description of the shares related to the election, the date or dates when they will vest, the nature of the restrictions or requirements tied to the shares, and the shares’ fair market value at the time of transfer are all required to be included in the letter.
Send the form to the IRS center – If you’re mailing your return, use certified mail with the return receipt requested. It will serve as evidence that it was received. FedEx, UPS, and DHL Express are all accepted by the IRS. However, you must utilize a service that has been approved.
Send one copy to the employer – In certain instances, the employee may file an application under Section 8 with the regulating authority, which decides on the disagreement over gratuity payment after hearing both the employee and the employer. One copy must be sent to the employer.
Check all the state tax laws – The statute aids in determining taxable income, tax liabilities, appeals, fines, and prosecution for taxpayers. The statute has been amended by the government on a regular basis.
Keep a copy for records – You can run your business more efficiently if you keep good records. Good recordkeeping might serve as proof that you’ve thought things through and taken the required steps. If you are questioned or challenged, your records become your defense. You’re in danger if you don’t have them.

Need help with your 83(b) election filing?

Making a Sec. 83(b) election and notifying the IRS in a timely manner is the greatest strategy for avoiding the problem in the first place. You can engage specialists such as Eqvista to assist you in completing Section 83(b) election. Reach out to us today to learn more!