Who doesn’t like to save money? An overview of 83(b) Elections
For those of you who like to save money, here’s some info on 83(b) elections.
What is an 83(b) Election?
Founders often receive restricted stock, which is stock that vests over time (for a refresher, check out our post on vesting). Section 83(b) allows founders to choose when they are taxed on restricted stock, either when they are granted rights to the stock or when the stock actually vests.
Section 83(a) of the Internal Revenue Code provides that founders will not recognize the value of stock until it vests. Usually delaying (and minimizing) taxes is a primary goal of tax planning. Under 83(a), founders would be required to recognize the value of the vesting stock at the time the stock vests, not at the time that the stock rights were granted.
In contrast, Section 83(b) allows founders to recognize the entire value of the stock at the time the rights in the stock are granted. Because founders typically receive restricted stock at the time of formation, the fair market value of the stock is nominal and there is no recognizable gain upon receipt of the founders stock, and thus no taxable income to recognize.
Where restricted stock is expected to appreciate significantly in value it would be wise to recognize the taxable income on the stock at the time the rights are acquired, and not at the time when the stock vests.
Time is of the Essence
After you receive your vested stock you only have 30 days to file your 83(b) election. If you fail to make your election within this time period, you lose all rights to make such an election.
A Horror Story
In the highly recommended book Do More Faster by Brad Feld and David Cohen, Matt Galligan tells a story about how he sold his first company to AOL and learned the hard way about 83(b) elections. His lawyer had given him a form to fill out and mail to the IRS, but the form never made it to the mailbox. Matt’s company had appreciated significantly in value between formation and sale to AOL. He ended up paying way more tax than he would have if he sent his 83(b) election to the IRS.
Making an 83(b) Election
Your statement must be sent to the IRS and indicate that you are making the election under section 83(b) of the code. To satisfy section 1.83-2(e) of the treasury regulations, your statement must have the following information:
(1) The name, address and taxpayer identification number of the taxpayer;
(2) A description of each property with respect to which the election is being made;
(3) The date or dates on which the property is transferred and the taxable year (for example, “calendar year 1970” or “fiscal year ending May 31, 1970”) for which such election was made;
(4) The nature of the restriction or restrictions to which the property is subject;
(5) The fair market value at the time of transfer (determined without regard to any lapse restriction, as defined in §1.83–3(i)) of each property with respect to which the election is being made;
(6) The amount (if any) paid for such property; and
(7) With respect to elections made after July 21, 1978, a statement to the effect that copies have been furnished to other persons as provided in paragraph (d) of this section.
If you’re a founder who’s about to receive restricted stock, make sure you at least talk to your lawyer or CPA about filing an 83(b) election; it could save you from donating piles of hard-earned cash to the IRS.