Restricted stock

The 83(b) election is an IRC provision giving an employee or founder the option to pay taxes upfront on the fair market value of restricted equity.

No 83 b election can be made on the receipt of a unit award because an 83 b election can only be made on the receipt of actual shares of stock. Certain actions, such as amendment of the certificate of incorporation, which typically occurs in connection with every venture financing, require stockholder approval. This is especially true when employees purchase shares subject to repurchase and when they purchase shares with promissory notes.

BREAKING DOWN '83(b) Election'

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In effect, an 83 b election means that you pre-pay your tax liability on a low valuation, assuming the equity value increases in the following years. However, if the value of the company instead declines consistently and continuously, this tax strategy would ultimately mean that you overpaid in taxes by pre-paying on higher equity valuation. Typically, when a founder or employee receives compensation of equity in a company, the stake is subject to income tax according to its value.

The fair market value of the equity at the time of granting or transfer is the basis for assessment of tax liability. The tax due must be paid in the actual year of stock is issuing or transfer.

However, in many cases, the individual receives equity vesting over several years. Employees may earn company shares as they remain employed over time. In which case, the tax on the equity value is due at the time of vesting. In each of the five vested years, he will have to pay tax on the fair market value of the , shares vested.

If at a later time, all the shares sell for a profit, the co-founder will be subject to a capital gains tax on his gain from the proceeds of the sale. The 83 b election gives the co-founder the option to pay taxes on the equity upfront before the vesting period starts. The 83 b election notifies the IRS that the elector has opted to report the difference between the amount paid for the stock and the fair market value of the stock as taxable income.

However, if he sells the shares for a profit, a capital gains tax will be applied. The 83 b election makes the most sense when the elector is sure that the value of the shares is going to increase over the coming years. Also, if the amount of income reported is small at the time of granting, an 83 b election might be beneficial.

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