When you’re a business founder, you have to learn the ropes quickly. You have to stay agile with your money and make use of every dollar, especially when Tax Day rolls around.
What if we said you could get a tax benefit on your stock options?
You can through an 83b election. Here’s what it is, why you should file it, and how to do it.
What is an 83b Election?
An 83b election is a provision under the Internal Revenue Code (IRC). To understand how it works, you need a basic understanding of stocks.
Let’s say you’re a business founder. Typically, business founders purchase stocks based on restricted stock agreements. These restricted stock agreements allow the company to repurchase “unvested” stock upon termination of employment.
In finance, vesting is the transfer of full ownership of a financial instrument. So, in restricted stock agreements, companies can repurchase stocks that haven’t fully transferred to the founder.
Similarly, employees can exercise options subject to the company’s ability to repurchase unvested stocks upon employment termination.
Under section 83 of the IRC, the founder or employee would not recognize income until the stock vests. In this case, income is the difference between the fair market value of the stock and the price they paid to purchase the stock.
However, if an employee or founder filed an 83b election, they voluntarily tell the IRS to recognize income upon the purchase of the stock, even if the stock hasn’t vested.
Why File It?
Typically, when a founder or employee receives equity compensation (like stocks), their stake is subject to income tax according to its value.
The fair market value of the equity at the time of grant is used to assess tax liability, and the tax due must be paid in the year of issue or the year of transfer. In many cases, however, individuals receive equity vesting over several years, as with an employee who earns company shares the longer they stay.
In that case, the tax on the equity value is due at the time of vesting.
If we assume that the company goes up in value over an extended period of time, then the value of the equity rises over time, which raises your tax liability.
However, in most cases, the fair market and the purchase price of the stock are the same at the time of purchase. Since your tax is calculated based on the gap between the purchase price and the fair market value (income), you won’t have any income to tax if you recognize “income” upon purchase of the stock.
So, an 83b election allows you to pre-pay your tax liability at a lower valuation.
How to Complete an 83b Election
The good news is that filing an 83b election is easy.
You used to have to complete an 83b form within 30 days of your award date. Now, you don’t need to do anything special. The IRS doesn’t even require you to include an 83b form anymore.
The fair market value of your award should already be included in your W2 or 1099-MISC, box 7. The election must be made no later than 30 days after the award date and is handled through your payroll department.
More Tax Guidance for Business Owners
An 83b election is just one small part of your tax strategy.
If you want to run a business that lasts, you have to learn your tax regulations like the back of your hand. We can help. Check out our blog for more useful tax tips today!