Understanding the 83b Election for Startups and Founders

Startups normally have to deal with the fact that finances may be limited. Revenue could still not be stable and investors could still be dragging their feet. Finding ways to do things in a cost effective way is therefore a major part of doing business for all involved. Taxes are an unavoidable part of any system. This does not mean that they should chip away at your finances through high rates. Understanding the tax code in your particular area of operation and its various provisions will ensure that you avoid overpaying.

In this article, we explain how you can better manage your tax budget by taking advantage of the 83(b) election. You will get to know what an 83b election is, how it can benefit your situation and how to go about filing it.

The Fundamentals of 83b Elections

Definition and Overview of 83b Election

A section 83b election is part of Section 83 of the Internal Revenue Code. It is a document you fill and send to the IRS to request that they tax company shares that you acquire when they are granted rather than when they are vested. The grant date is the day you receive the shares while vesting happens when one earns actual ownership after satisfying the conditions that may have been agreed upon.

With an 83b election you are making the choice to pay taxes on the value of the stock on the day of granting rather than when you become vested in the stock. You pay tax on the current value and not on whatever the value might be later. Filing a 83b election is optional though it is noteworthy that not filing one means that you could be taxed on the value of the stocks upon vesting.

Eligibility Criteria for Making an 83b Election

You are eligible to file for an 83b election if you fall into these categories:

If you are a stock option holder, say you have received a stock grant from your employer, you can minimize your future tax bill by filing an 83b election within 30 days of the grant date.

If you are a company founder or owner your compensation could include restricted stock. These are company shares that are expected to experience a considerable rise in value between grant date and vesting. In such a case you can also benefit from filing for an 83b election.

The Role of a Fractional CFO in Managing 83b Elections

A fractional CFO provides financial guidance to a startup on a part time basis. The CFO’s key role is that of a financial advisor to the startup. They will review the startups financial records for accuracy and make suggestions to optimize budget and performance as a whole.They will also help out in the area of operations by providing guidance on tax eligibility and application processes. This will include management of 83b elections. A good fractional CFO will help the founders, owners and employees understand tax code regarding 83b elections and ensure that applications are made correctly.

Timing and Importance of Early Election

The 83b election should be filed within 30 days of the grant date of your company shares.

Strategic Tax Implications of the 83b Election

Tax Benefits of Filing an 83b Election

The main benefit of filing an 83b election for a co-founder is the fact that they will only pay taxes on the fair market value of the shares and not what it may cost to exercise their options. This tax strategy of paying tax on shares on granting instead of on vesting will therefore minimize tax costs.

Long-Term Tax Considerations and Planning

It is a good idea to file an 83b election if you are planning to stay in the company until your shares are vested. It is important that you plan to stay for a while in the company because leaving before your shares are vested could mean you end up not receiving shares that you already paid tax for. If all forecasts show that the company shares will go up, then it would also be a good idea to file an 83b election. The 83b election benefits the application by reducing their tax burden in the long term.

Comparing Tax Outcomes: With and Without an 83b Election

When you make a timely filing of an 83b election within the stipulated 30 days, you will pay ordinary income tax at 37%. Because you filed an 83b tax election, you will not pay tax when the stock vests. You will be required to do so if taxable gain is apparent after the sale at the capital gain rate of 20%.

When you do not file an 83b election, you pay no tax on granting. Instead you will pay tax on the income apparent and increased value of the shares on vesting at 37%. At the time of the sale, you will be liable to pay 20% capital gains tax on any taxable income.

Not filing an 83b election in this case will cost you more.

Scenario Analysis: Immediate Taxation vs. Deferred Taxation

Filing an 83b election at the offset is a saving and a reduction on the tax burden. Waiting to pay the taxes later by not taking advantage of the 83b election could mean a higher tax bill resulting from the amount to be paid at vesting.

How to File an 83b Election and Common Pitfalls

Step-by-Step Guide to Filing an 83b Election

Filing an 83b election form is a straightforward process. You need to be careful to fill in the form correctly and most importantly in a timely manner. Filing must be done within 30 days of receiving your stock grant. Seek the help of your fractional CFO or a tax professional if you need to.
Prepare your 83b election form. Fill out the form and make sure all the necessary information is provided.
Make 3 copies of your form. One goes to the IRS. The second copy goes to your startup. Keep the third copy safely for your records.
Visit your local post office to request a certified mail service. Fill in and attach the certified mail form to your envelope or as directed. After making your payment, make sure to safely keep your receipt as proof of mailing. Use the tracking number on the receipt to track your documents. You will get a delivery confirmation once the documents are received at the IRS.
Consult your fractional CFO or tax professional about adding a copy to your state returns.

It is important that you file your 83b election within the required time. Also clarify with your fractional CFO when the grant date actually is. It could be the date the board approves the grant and opposed to the day you get it.

Case Studies: Real-World Applications of the 83b Election

Startup Founders and Early Employees: A Comparative Analysis

Founders and early employees are the backbone of a startup. Founders are more attached to the startup while employees might find it easier to leave or move on to other ventures. The departure of an initial employee however, is very likely to negatively affect the startup since they carry with them knowledge and experience of what really made the system work right from the beginning.

Lessons Learned from Missed Opportunities and Election Errors

Missing an opportunity to file an 83b election either by not filing on time or making errors on the form can impact a startup negatively. Increasing the tax burden could dig into the budget in the form of taxes that could have been avoided.

FAQs: Understanding the 83b Election in Depth

What is an 83b election and who can benefit from it?

An 83b election is a request to the IRS to allow you to pay tax based on the current value of the stock on the grant date instead of whatever the value will be on vesting.

How does an 83b election affect future taxes?

An 83b election will minimize your tax burden if filed correctly and on time.

What are the deadlines and procedures for making an 83b election?

An 83b election must be filed within 30 days of the grant date. A form is filled and sent preferably by certified mail to the IRS.

Additional Considerations for Startups and Founders

The Role of Equity Compensation in Startups

Startups offer equity compensation to save money. It is a method used by startups to get the staff they need without negatively affecting their budget.

Legal and Financial Advisory: Ensuring Compliance and Maximizing Benefits

Startups can benefit greatly from contracting the services of a fractional CFO and seeking the services of legal and tax professionals. Having a fractional CFO on board can help a startup ensure it is complying with tax laws.

Conclusion: The Significance of the 83b Election for Startups

An 83b election is an effective way to minimize your tax burden. Since every startup is different and presents unique challenges, it is important to have a financial professional on board to examine and analyze all the different factors that go into deciding if this election is the best way for you to go.