One of the most critical tax considerations that will be made by the founders of early-stage startups is whether or not to make an election under section 83(b) of the Internal Revenue Code for stock awards or other acquisitions of vesting shares. Founders will avoid missing the 83(b) filing deadline by making this decision immediately after securing the shares to shield themselves from significant tax repercussions down the line.
In this article, the meaning and significance of Section 83(b) will be discussed in detail.
What is Section 83(b) Election?
A section 83(b) election is a tax decision to include in your income the fair market value of the property you have earned in accordance with service results that you may not be able to keep.
Normally, under the tax code, if you obtain property in accordance with the performance of services that you may not not be able to maintain and that you may not be able to transfer, you do not have to take the fair market value of that property as income until it is decided that either (I) you will be able to keep it or (ii) that the property will be transferable.
Founders who decide to make an election in 83(b) must do so immediately to ensure that they do not meet the filing deadline of 83(b). An election of 83(b) must be filed with the IRS within 30 days from the date of the restricted stock grant or purchase The last available day for filing is determined by numbering each day beginning with the day after the date of the grant.
The importance of Section 83(b)
There are many explanations why filing an election under 83(b) may be useful to a founder. Perhaps importantly, section 83(b) of the Internal Revenue Code allows creators to speed up the calculation of taxable income on an award or purchase of restricted stock by the day it was issued, rather than by the date(s) the shares were vesting. If the limited stock is acquired at an amount equal to its fair market value, an election of 83(b) would result in no acknowledgment of income as of the date of purchase.
Once founders file an 83(b), they can save taxes, delay tax obligations easily, and start the clock used to assess whether or not the income was long-term or short-term.
Risk factor of an 83(b) election
Despite its advantages, the election to 83(b) is not without risk. Having an election under section 83(b) speeds up the date taxable income is recognized from the day of vesting to the day the restricted stock is granted or purchased It assumes that if a founder takes an 83(b) election pays income tax on the basis of the fair market value of the shares on the day of the award, and then then forfeits his or her shares, the founder may have paid income tax.
Besides making a valid 83(b) election, it's important to get evidence that you did so. As part of the legal due diligence process, VCs and potential acquirers will look for this evidence, since missed 83(b) elections can cause a lot of problems for startups away in the future.
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