By: Alyson Furey​

*** We are only covering an 83(b) Election in the context of founder issuance or issuance of stock (or early exercise of stock options) subject to an equity incentive plan – this is NOT tax advice – you should seek advice from your own tax advisors***

“Do I need to file an 83(b) election?” is one of the most frequent questions we receive when issuing founder stock or equity under equity incentive plans. Filing an 83(b) election, if appropriate, could have major tax implications.

Section 83(b)
Founders or early employees typically make Section 83(b) elections on stock purchases subject to vesting. If you’re reading this post and have a fully vested stock (or thinking of exercising your vested stock options), you can stop now. The question of whether you make an 83(b) election or not does not apply to you because your stock is likely not subject to a substantial risk of forfeiture.

Section 83(b) of the Internal Revenue Code requires the founder or employee to recognize income when the stock ceases to be subject to a substantial risk of forfeiture (read “vests” for most purposes)*. But if the founder or employee makes a Section 83(b) election, he or she will recognize the income as of the purchase date of the stock. In most situations of an early stage company, if an 83(b) election is made, there is no income realized or recognized because the purchase price for the stock and the fair market value are the same (hence no income from a difference in purchase price and fair market value).

Why does this matter?  Imagine a scenario where the stock is subject to vesting over four years.  Let us say that the stock is work $0.001 per share at the time of original issuance.  Let us say further that in year 4, the last year in which vesting ceases, the stock is worth $1.25 per share.  Instead of recognizing no income because you paid for your stock when you bought it in year 1, you recognize income at $1.25 per share.  Additionally, if you sell your company in year 5, you may be subject to ordinary income tax rates instead of long term capital tax rates.

This is not meant to serve as tax advice – you need to consult your personal tax advisor on whether you WANT to file an 83(b) election.  Here we just strive to answer the question – do I need to consider making one or not?
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*There can be other conditions on a stock that make it likely to be considered under a substantial risk of forfeiture.  For most purposes in the start-up context, that means just forfeiture at original price or very low price.

83(b) Essentials

1. An 83(b) election must be filed with the IRS within 30 days after the purchase date. There are no exceptions to this rule. If you miss the deadline, you miss the opportunity to make the election.
2. The election should be filed by mailing a cover letter and two (2) copies of the signed election form by certified mail, return receipt requested, with a self-addressed stamped return envelope to the IRS Service Center where the individual files his or her tax returns.
3. The individual should retain one copy of the election to submit with his or her tax return and an additional copy should be given to the company.
4. If you live in a state where state income taxes and returns must be paid and file, you should look to see if a copy needs to be included with that state filing.

By: Alyson Furey

​One of the most important decisions you can make in your company’s life cycle is your choice of entity. Think about it in this light: you have a child preparing to choose a college. Princeton and Harvard are both great options, but each comes with their advantages and disadvantages. Either way your child will come out educated and successful, but the college you choose will largely dictate their path and opportunities in life. In start-up land, your company is your “child,” Princeton is an LLC, and Harvard is a C-Corp. Where you want your company to end up in the next quarter, next year, and next five years matters in choosing your entity structure.

​C Corps
C Corps (corporations taxed under Chapter C of the Internal Revenue Code or your standard “Inc.”) are by far the most common choice of entity when forming a tech startup company that will seek venture financing in the near term. First, most investors prefer C Corps because (1) they are familiar with the structure, (2) C Corp structures are fairly rigid, and (3) they can have separate classes of stock to create different preferences and share valuations. C Corps can also offer incentive stock option plans in a fairly straightforward, easy to administer way to attract key employees. On the downside, C Corps are subject to double taxation. Meaning they are taxed once at the corporate level as a separate entity, and again with the stockholders based on dividends or distributions*. To offset this, VCs point out that most startups are not in the business to declare dividends, but rather, the early shareholders plan to exit through a sale of the company or IPO someday.  Additionally, a C Corp shareholders may take advantage of Section 1202 of the Internal Revenue Code pertaining to the exclusion of certain capital gains if certain conditions are met.

LLCs
LLCs (or Limited Liability Company) are ideal for startups that plan to bootstrap or be financed by a small number of investors, but are not ideal for venture capital investing or multiple rounds of investments. Typically, an LLC’s taxable income is passed through to the individual members meaning that the LLCs earnings are only taxed once, at the member level. LLCs are extremely flexible when it comes to management or ownership structures, managed more informally, and are not held to the same corporate formalities as C Corps. This same flexibility can be seen as a hindrance to some investors, so some will not invest in this type of entity structure.  LLCs can still offer employees incentive membership interests in the LLC, but they are unable to offer incentive stock options to employees like the C Corp can and administration of such plans can be more burdensome.

Our Two Cents
In sum, if you are planning to begin a financing round or know that you will be seeking venture financing when forming the company in the next 12 -18 months, you may want to be a C Corp from the start. Conversely, if you will be bootstrapping your startup or receiving funds from a small number of investors, an LLC may be your better choice.

*unless your company qualifies as a Qualified Small Business and the stock is Qualified Small Business Stock under Section 1202 of the Internal Revenue Code.  Blog post on this coming soon.


We would love to speak more with you about your specific startup in order to give you the most prudent advice. Please visit our Contact page with any questions about what entity structure would be best for your startup.
 
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