30 Days to Decide Your Tax Destiny

Founders and early employees in startups often find themselves facing a crucial decision when granted equity compensation: Should they file an 83(b) election? This choice can significantly impact their future tax liability, and understanding its implications is essential.

What is an 83(b) Election?

In essence, an 83(b) election is a tax strategy that allows you to prepay taxes on your equity compensation, such as restricted stock or stock options, at the time of grant rather than when it vests. This seemingly counterintuitive move can lead to substantial tax savings down the line, especially if your company’s value appreciates significantly.

Quick clarification for everyone: you file the 83(b) within 30 days of when you exercise your stock options, not when you are granted them. The taxable event occurs when you exercise your options & purchase that stock – before that there has not been a taxable event to realize any income.

The Tax Landscape

To understand the benefits of an 83(b) election, it’s important to grasp the difference between ordinary income tax and long-term capital gains tax. Ordinary income tax, which applies to your salary and bonuses, is typically higher than the long-term capital gains tax, which applies to profits from selling assets held for over a year.

Without an 83(b) election, you’ll be taxed on the difference between the stock’s value at vesting and its grant price as ordinary income. With an 83(b) election, you pay taxes on the value at grant, and any future appreciation is taxed at the lower capital gains rate when you sell the stock.

Should You File?

The decision depends on several factors:

• Company’s Potential: If you believe the company’s value will skyrocket, an 83(b) election can lock in a lower tax basis early on, saving you money in the long run.
• Financial Situation: Can you afford the upfront tax bill that comes with an 83(b) election?
• Risk Appetite: If you leave the company before your shares vest, you lose both the shares and the taxes paid.
• Type of Equity: The type of equity you receive (restricted stock, stock options) impacts the tax implications.

Pros and Cons

• Pros:
  • Potential for significant tax savings in the long-run.
  • Earlier start to the long-term capital gains holding period.
  • Potential reduction in AMT (Alternative Minimum Tax) exposure.
  • Can signal commitment to investors.
• Cons:
  • Upfront tax liability.
  • Risk of forfeiture and loss of taxes paid.
  • No benefit if the stock price declines.

Who Should Consider Filing?

• Founders and early employees receiving restricted stock or stock options.
• Individuals confident in the company’s growth and willing to accept the risks.

Risks of Not Filing

• Higher tax liability at vesting if the stock appreciates significantly.
• Potential AMT complications.
• Missed opportunity for long-term capital gains treatment.

Seek Professional Guidance

The decision to file an 83(b) election is complex and should not be taken lightly. Consult with a tax advisor or startup lawyer to understand the specific implications for your situation. They can help you weigh the pros and cons, model different scenarios, and ensure you make the best choice for your financial future.

Remember: The 30-day deadline for filing an 83(b) election is strict. Don’t delay seeking advice and making an informed decision.

.M

Disclaimer: This article is for informational purposes and is absolutely not legal advice. Consult with a qualified professional for personalized guidance before you make your own life decisions.

Sources and more related content

• What is an 83(b) election? – Carta
• Why You Should You File an 83(b) Election – HBS
• What’s the Big Deal? – ec/vc law

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