Unlocking Tax Savings: The 83(b) Election and Its Impact on Businesses
Oct 17, 2023
What is 83(b) Election?
The 83(b) election is a provision in the United States Internal Revenue Code, specifically Section 83(b), that allows employees or founders of a company to choose to include the value of certain stock or other equity grants in their taxable income at the time of grant rather than when the stock or equity vests. This election is named after the section of the tax code that governs it.
Why Does It Matter for Startups?
The 83(b) election holds significant importance for startups, especially for employees or founders who receive stock options, restricted stock units (RSUs), or other types of equity grants as part of their compensation. Making an 83(b) election can provide potential tax advantages.
Here's why it matters:
Tax Savings: By electing 83(b), individuals can pay taxes on the value of shares at the time they are granted, even if they are subject to vesting. This allows for the potential realization of tax savings, as any future appreciation in the shares will be subject to capital gains tax rates rather than ordinary income tax rates. This is particularly beneficial if the value of the shares is expected to increase significantly over time.
Alignment of Interests: Startups commonly use equity grants as a means to align the interests of employees and founders with the success of the company. By providing an opportunity to participate in the potential upside, it incentivizes individuals to contribute to the growth and value creation of the startup.
How Does It Work?
When an individual receives equity grants, the taxable event typically occurs when the stock or equity vests. At that point, the fair market value of the shares is included in their taxable income, subjecting them to taxes on the appreciated value of the shares.
With the 83(b) election:
The individual chooses to pay taxes on the value of the shares at the time of grant, regardless of vesting.
By paying taxes on the lower value at grant, any future appreciation in the shares will be subject to capital gains tax rates rather than ordinary income tax rates.
The election must be made within 30 days of receiving the equity grant. Failing to make the election within this timeframe forfeits the opportunity to do so.
It's crucial to consult with a tax professional or an attorney experienced in equity compensation before making an 83(b) election. The decision should be based on an individual's specific circumstances and future expectations, considering factors such as tax implications, potential future value of the shares, and personal financial goals.
Tax laws can be complex, and seeking professional advice ensures a thorough understanding of the implications and requirements of making the election.
Remember, the 83(b) election can offer significant tax benefits, but it requires careful consideration and timely action