Startup - 83b Election

83b Election is particularly important to Startups. We will try to put plain language around it so that you know when its relevant to you, and how to deal with it. In this article, we will focus on the definition, tax impact  with what if scenarios, and a quick step-by-step process of taking care of this. Alternatively, if you have a qualified legal counsel helping with the legal aspect of the corporate administration, you should be all set as well. As always, reach out to us if you have questions. 

What is 83b - all about Taxation 

83b is a section in the Internal revenue code that deals with your personal income tax. It become relevant to you if all of the following conditions are met: (please note, stock OPTION grant is not applicable for 83b election)

  • you were issued/granted Restricted Stock (another word for stock subject to vesting) subject to certain vesting schedules
  • the stocks granted to you (not vested yet) have a very low price (we are talking about less than a penny most of the time) and 
  • there is a HIGH probability it will increase in values significantly (we are talking about more than 10 times maybe)


To help better explain the above points. here is a typical example in the startup space that give good reasons for a 83b election

  • You are a founder, co-founder, or early member of a startup/company that issued/granted you stocks subject to 4 year vesting (restricted in this case)
  • The stock par value (meaning company have just an idea ) is really low, like 0.0001 per share (most startups issue 10M authorized share with 0.0001 per share as a starting point)
  • You reasonably believe that the value of the stock as they become vested to you will worth more than what they are stated today

 

Scenarios when 83b election is made or is not made 

Because it is purely a tax implication, we will show you the tax consequences on either side of the equation. Continuing on the above example, lets say you were issued 1M shares with 0.0001 per share, with 4 years of vesting starting today. And same time today, you saw this article and made the 83b election. What will happen is that you will include 100 dollars (1M x 0.0001) in your current year's taxable income as regular earning. Assuming your current year tax rate is 25%, then you just incurred a dollar tax liability to the IRS. For sake of simplicity, we don't care about your deductions or state income tax. 

But what if you didn't file 83b, because you forgot. Well, after 30 days of being issued/granted with the above shares, you can no longer make a valid 83b election. Not making the election means you have no income tax immediately, but lets say your stock increased value (most likely through future 409A study), and the 409A study says the stock worth 0.50 per share 2 years from now. At this 2 years mark, you have vested 500K shares. Now, you need to include 0,000 (500K x 0.50) in your taxable income this year, and your tax liability or cash outflow to IRS is now ,500. If you have made the 83b election, you would have no cash flow. 

Okay, at this point, its obvious that you would not want to pay IRS this amount, and making the 83b election is a much smarter choices. What we didnt go further or consider is the scenario when the stocks were sold. The cash flow impact for selling the stock under either choice is actually not a huge different but making the 83b election still come out slightly ahead. 

Here is the worst case scenario when you dont make the 83b election – When all of your stock were vested, and you paid all the taxes but your company failed. If that happens, you can only recoup minimal tax paid from claiming capital loss on your tax return with a 00 limit each year. 

Conclusion? – Make The 83b Election Every Time!

 

Step-by-Step Guide to filing your 83b election 

Step 1: Download the Template from IRS by clicking this Link (go straight to page 9) and filling out the template. I recommend filling out, sign and date 2 identical forms 

Step 2: Prepare a self stamped and self addressed envelop along with the forms you just filed out and write a letter to the IRS to return a copy to you

Step 3: Mail everything together to IRS address based on where you live, you can reference the address in the chart below

If you live in Address to Mail 
Alabama, Arkansas, Delaware, Georgia, Indiana, Iowa, Kentucky, Maine, Massachusetts, 
Missouri, New Hampshire, New Jersey, New York, North Carolina, Oklahoma, South Carolina, 
Tennessee, Vermont, Virginia

Department of the Treasury 

Internal Revenue Service 

Kansas City, MO 64999-0002

Florida, Louisiana, Mississippi, Texas

Department of the Treasury 

Internal Revenue Service 

Austin, TX 73301-0002

Alaska, California, Hawaii, Illinois, Michigan, Minnesota, Ohio, Washington, Wisconsin

Department of the Treasury 

Internal Revenue Service 

Fresno, CA 93888-0002

Arizona, Colorado, Connecticut, District of Columbia, Idaho, Kansas, Maryland, Montana, Nebraska, 
Nevada, New Mexico, North Dakota, Oregon, Pennsylvania, Rhode Island, South Dakota, Utah, 
West Virginia, Wyoming

Department of the Treasury 

Internal Revenue Service 

Ogden, UT 84201-0002

A foreign country, U.S. possession or territory,* or use an APO or FPO address, or file Form 2555, 
2555-EZ, or 4563, or are a dual-status alien.

Department of the Treasury 

Internal Revenue Service 

Austin, TX 73301-0215

 

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