Tax strategies for non-transferred company shares

For founders, employees and executives with stock-based compensation, an 83(b) election generally is a powerful tax planning tool. When you make an 83(b) election, you’re selecting to pay taxes on unvested stock now, relatively than when the stock vests. Most tax planning strategies concentrate on deferring taxes, but an 83(b) election is all about accelerating them.

Why make an 83(b) election? The primary reasons to make an 83(b) election are to attenuate taxable income and to manage the timing of taxes. If you own stock options, founders stock, or restricted stock, here’s what you need to know concerning the 83(b) election for unvested company stock.

What is an 83(b) election?

Section 83(b) of the tax code gives individuals the chance to speed up the taxation of their stock grants. Typically, stock-based compensation is subject to certain vesting requirements: time, performance, liquidity events, possibly multiple aspects. Under standard taxation, there isn’t a tax impact at vesting since the taxpayer assumes the chance of losing the shares until the shares vest (or are exercised within the case of options). In tax parlance, this known as significant risk of loss.

However, there are some cases where it is useful for the taxpayer to appreciate this income now – before the shares vest. This may be achieved through an 83(b) election. For restricted stock, this implies paying taxes on the taxable spread on the grant, relatively than when the shares vest. If you’ve got stock options, an 83(b) election may be used along with a early training.

In each cases, the difference between the exercise price (or purchase price) and the present market value of the stock is taxable, either as extraordinary income (for restricted stock and non-qualified stock options) or for the alternative minimum tax (AMT) calculation (for incentive stock options). If elected, any subsequent taxation is deferred until the shares are sold.

Who could make an 83(b) election and for what form of stock compensation?

Startup founders, early employees, executives, and other service providers could make an 83(b) election. For stock option holders, the corporate must allow early exercise.

The following are the sorts of unvested stock awards which might be eligible for election (assuming the shares haven’t yet vested):

• Restricted shares (no restricted shares units)
• Founder shares (this will not be a legal term and frequently refers only to common stock)
• Incentive stock options
• Non-qualified stock options
• Profit sharing in an LLC or partnership

Important appointments: For restricted stock, an 83(b) election have to be made inside 30 days of the grant or the spread is subject to regular income tax whether it is vested. For stock options, the filing period is 30 days from Exercise.

3 Key Benefits of an 83(b) Election

Under the fitting circumstances, the 83(b) election generally is a very effective tax planning tool.

1. Potential for tax minimization

As illustrated within the examples below, electing 83(b) can dramatically reduce taxes in certain circumstances. An 83(b) election is often most helpful when accelerating income when the taxable range is at or near zero. Stocks of early-stage startups typically have a really, very low valuation, making this tax strategy feasible. Provided holding periods are met (more on that below), it is feasible to completely shift taxable income to more favorable long-term rates through an 83(b) election.

2. The period for tax-favorable holding periods begins

The election sets several essential holding periods in motion:

3. More control over your tax situation and your equity

Another good thing about the 83(b) election is that you’ve got more control over your tax situation. Before making the election, seek the advice of your tax and financial advisor to know the impact in your tax situation and make an informed decision.

This election can assist you to avoid money flow and tax headaches within the years to come back. Without this election, restricted stock grants and early-exercised stock options can have tax implications every time shares vest, because the difference between the longer term market value of the stock (less the acquisition/exercise price) is subject to regular income tax (that is AMT income for ISOs). For fast-growing startups, this generally is a big problem, especially if there isn’t a public marketplace for the shares.

For employees with stock options, the 83(b) election could also be essential later when valuations rise. A large spread makes it very financially difficult to exercise shares before the choices expire. leave the corporateIt might also lead to some tax planning strategies not being implemented later.

Tax laws change recurrently, and one other change is planned for 2026. Accelerating the taxation of stock compensation could mean the introduction of more favorable tax rules. At the very least, it means taxpayers are less affected by financial problems which might be outside of their control.

Considerations before the 83(b) election

Like every part in the private finance world, making an 83(b) election is not all the time a walk within the park. Here are some things to be mindful.

• The stock may not rise. The risk of filing an 83(b) election increases with the price of shopping for the stock and/or the taxable spread because you’ve got more money at stake. There is the chance of paying an excessive amount of in taxes if the valuation doesn’t increase or the corporate will not be successful.
• Your shares must still be vested. An 83(b) election is irrevocable. Make sure you comply with the vesting requirements.
• Your holding period will not be guaranteedRegardless of how long you propose to carry the stock, M&A activity, repurchase rights and other events can intervene.
• Cash requirements. Depending on the strike price and valuation, an early exercise can still be money intensive. Make sure it is sensible within the context of your financial situation and goals.

Simplified hypothetical example: Early exercise of non-qualified stock options with an 83(b) election

For simplicity, the next example ignores payroll taxes and state tax implications.

• Strike price = 0.1 USD
• Current valuation = 0.1 USD

Normal income upon early exercise = $0. Assume shares vest after over a yr and may be sold for $6/share. Long-term capital gain = $5.90/share.

The election resulted in no regular income being generated and all the gain being converted right into a long-term capital gain. The highest tax rate on long-term capital gains is currently 20%.

Without the election and assuming early exercise, the worker would have extraordinary income of $5.90 per share at vesting, no matter whether she or he sold the shares. The highest extraordinary income tax rate is currently 37%.

Planning notes:

• Now let’s assume that in the instance above, the choice was exercised after vesting. In this case, the traditional income can be the identical (assuming there aren’t any changes to the valuation), but the worker would determine the timing. Therefore, it will likely be best to exercise the choice early with an 83(b) election or consider delaying the exercise.
• The tax treatment in the instance above could be very similar for restricted stock. However, restricted stock lacks the pliability that stock options have in controlling the exercise date.
• Incentive stock options have to be held for not less than two years from the grant date and one yr from the vesting date to profit from long-term capital gains tax. For executives who can negotiate their stock compensation, other types of stock compensation could also be more favorable depending in your goals.

Long-term planning with equity compensation

If you are a founder or stock-based compensation makes up a big a part of your salary package, it pays to think long-term and strategically. For startup employees particularly, the tax and financial steps they take early on are sometimes essentially the most critical to constructing wealth.

But it’s equally essential to stay realistic about an organization’s time horizon, risk, and prospects. Deciding whether to make an 83(b) election is only one piece of a fancy puzzle that needs to be considered and discussed together with your personal financial and tax advisors.