What’s all the fuss about the section 83b tax election?

Let’s start with the premise that everyone needs to comply with the tax code. With that said, taxes are like chores. You pay what you must, but no more than you need to.

One way to avoid overpaying is to understand the tax code and its various provisions. This can be especially true if you have a complicated tax situation, as employees or company founders with equity compensation often do. Taking advantage of the 83(b) election can help you minimize your tax outlay.

A Section 83(b) election is a letter that lets the Internal Revenue Service (IRS) know you’d like to have your founder stock taxed at the time of your stock issuance rather than at the time of vesting. In many cases, a Section 83(b) election can save you a significant amount on future taxes.

Most importantly, if you make a Section 83(b) election, you won’t pay taxes when your stock vests. Instead, you pay very little (if any) taxes at the time of stock purchase, and you won’t owe taxes until you sell your stock.

If you don’t make a Section 83(b) election, you could owe a large amount of taxes every time your stock vests, especially if the stock value has increased. You’ll also have to pay taxes when you sell your stock. This is because the IRS treats a grant of stock with value as income when it’s received.

Note that the 83(b) election only applies when stock is subject to some vesting, often a condition imposed when a venture capital firm invests in a startup.  If you have already formed your company and subscribed for all of your shares, this doesn’t apply.

Why should I?

Rooney Law almost always recommends filing a Section 83(b) election if founders purchase their stock when the company is still in its early stage. If you recently incorporated your startup, you should consider making a Section 83(b) election for your founder’s stock if your stock is subject to vesting and you expect your stock value to go up, and you plan to stay employed with your company until all your stock vests.

Not all stock is eligible for a Section 83(b) election, but if you’re incorporating your company with co-founders and have agreed with your founders that stock will vest over time, your stock is eligible because it’s subject to vesting.  One reason founders or VC firms may want their co-founders to have stock subject to vesting is to ensure that everyone is equally committed to spending time on the venture.  Certainly, if issuing restricted stock to employees post any investment round, 83(b) elections are critical,

Another advantage of an 83(b) election is that it allows individuals to avoid or minimize the Alternative Minimum Tax (AMT). The AMT is a parallel tax system that prevents taxpayers from using deductions and other tax breaks to reduce their tax liability too much. By making an 83(b) election, individuals may be able to reduce their AMT liability by paying taxes on the stock at its current value.

Why not? Reasons not to file a Section 83(b) election.

If you believe the value of your company’s stock will decrease by the time it vests, or if you think your company might not employ you until your stock vests, you might not want to make a Section 83(b) election. Similarly, if you are forming a new company with no assets, income, or valuation, there’s no real point in making the election.

If you’re not a US taxpayer and don’t plan to be, there’s no benefit from making a Section 83(b) election.

What do I need to do?

Mail your election no later than 30 calendar days after the stock is issued. There are no exceptions to this rule—this is a strict deadline.

The 30th day is calculated by counting every day (including Saturdays, Sundays, and holidays) starting with the day after the date you’re issued the stock. For example, if you’re issued stock on April 10 that’s subject to a vesting schedule, your Section 83(b) election must be postmarked no later than May 10. If the 30th day falls on a weekend or holiday, then the deadline is the next business day.

Since 2021, under Covid rules, the IRS has allowed entrepreneurs to submit documents signed via electronic (or pdf) signatures when filing 83(b) elections.

This common-sense reform to make the process more streamlined was uncontroversial–but is due to expire on Oct. 31, 2023. The IRS should make e-filing and e-signing of 83(b) elections and other documents permanent so that startup founders and early employees can more easily understand and comply with their taxes.

What if I’m not a US resident?

If you live outside the US but file US tax returns, you should still consider making a Section 83(b) election because the election might save you US taxes in the future.

If you don’t file US tax returns but think you might become a US taxpayer, you should still consider making a Section 83(b) election and applying for an Individual Taxpayer Identification Number (ITIN). If you don’t make the election and later become a US taxpayer when the stock vests, you could be subject to additional US tax liability as your stock vests.

If you’re not currently and don’t plan to become a US taxpayer, making a Section 83(b) election doesn’t matter because a Section 83(b) affects only US tax liability.

Does each founder have to file?

The Section 83(b) election is filed by an individual taxpayer, not the company. So, each founder needs to make their own decision about whether to make an election and must file it for themselves. However, future investors might expect that all co-founders and employees have filed a Section 83(b) election if there is stock subject to vesting.

Our take

We’ve seen many firms be obsessive about filing section 83(b) tax elections (including redoing multiple rounds of documents and canceling and regranting equity to address the situation.  We’ve seen law firms where associates send around 83(b) and require it be returned to them for filing. We’ve also seen an amazing amount of time spent on this issue.  It’s now a common rep and warranty in NVCA-documented deals.

Our impression is that 83(b) becomes a big deal at the time of an IPO (auditors love finding it) or strict accountants that require companies to calculate annually the value of stock that vests.

There are many ways of incentivizing employees and others besides direct stock, and we encourage you to consider those options as well.

We wouldn’t recommend to anyone that they fail to file, but you should always consult with legal and tax advisors before making the decision, especially if you’re not a US-based founder. If you need help or have questions, please drop us a line at +1 212 545 8022 or visit our website – www.rooney.law.

Read more insights from the Rooney Law team here.

© 2023 Rooney Law. All rights reserved. Rooney Law PC is an international corporate law firm. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner or equivalent in such a law firm. Similarly, reference to an “office” means an office of any such law firm. This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome. Nothing herein shall create an attorney-client relationship between the reader and Rooney Law PC

 

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