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?
*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
*** 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?
*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
- 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.
- 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.
- 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.
- 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.