Granted Stock Options? Filing an IRS Section 83b Election
Death & Taxes, But How Much In Taxes?When building or joining a new enterprise, we tend to get caught up in the most exciting and impactful aspects of our days. What can I build now? Who can I sell to now? Who might invest in the business? One thing we assume we can put off is thinking about our tax liabilities since any exit could be years away, but in reality that could be a massively expensive oversight. One that can be avoided with just minutes of work by filing an 83b Election. To see how, let me share a painful story about one of my clients. She received 5,000 shares of a company for her services, and at the time of receipt each share was worth $0.01. At the time, she was unaware of filing an 83b election with the IRS, and instead focused solely on the new role. But as her shares vested, she had to continuously pay each cycle for the increase in the value of her shares. As I show you the math exercise below, had her share price been locked in by filing this simple election, she would have saved nearly $50k in a lower total tax liability. She also would have been able to delay the need to pay any taxes on the gains until an exit event.
What is an 83b Election?The 83b Election allows you to fast track (aka pay upfront) your ordinary income related to increases in share value while (...here’s the key!...) locking in the share price at it’s current level until exit. When you make the election, you report the current value of your stock holdings as ordinary income in the tax year you received your shares. Your taxable income is the current value of the shares multiplied times the number of shares granted. If they are stock options, the most likely scenario is the current value is zero (typically the strike price is the current price of the shares, meaning the current value is zero). If they are restricted stock units (RSUs), then the math is more simple. Either way, you avoid reporting income each time additional shares vest. If you anticipate the value of the company to go up (which is not always the case), then you should highly consider making this IRS election.
When to Make the 83b Election:You have only 30 days from the date the shares were transferred to file an 83b Election. Given the time frame, you should consider filing the election with the IRS to ensure you do it before the election expires.
Here’s an example of how the 83b election impacted my client’s tax liability:The Facts:
- Taxpayer granted 5,000 shares for services performed
- 2-Year Vesting Plan
- Price per share $.01 @ Grant Date
- Income tax rate of 35%, long-term gains rate of 20%
At Time of Grant: Ordinary Income = 5,000 Shares X $.01 = $50 Total Tax Liability = $50 X 35% = $17.50
First Year – 2,500 Shares Vested @ $25: No income to report
Second Year – 2,500 Shares Vested @$50: No income to report
Company liquidates 2 years and 3 months later – Value Per Share $100: Long Term Capital Gains = 5,000 shares X $99.99 = $499,950 Tax liability = $499,950 X 20% = $99,990
Total tax liability paid since grant = $100,007.50If the Election IS NOT filed with the Initial Grant
At Time of Grant: No income to report
First Year – 2,500 Shares Vested @ $25: Ordinary Income = 2,500 Shares X $25 = $62,500 Tax Liability = $62,500 X 35% = $21,875
Second Year – 2,500 Shares Vested @$50: Ordinary Income = 2,500 Shares X $50 = $125,000 Tax Liability = $125,000 X 35% = $43,750
Company liquidates 2 years and 3 months later – Value Per Share $100: Ordinary Income (2nd YR Vested Shares) = 2,500 Shares X $50 = $125,000 Tax Liability = $125,000 X 35% = $43,750 Long Term Capital Gain (1st YR Vested Shares) = 2,500 Shares X $75 = $187,500 Tax liability = $187,500 X 20% = $37,500
Total tax liability paid since grant = $146,875You can read further on final IRS regulations for the 83b filing, and if you would like to chat further contact me at email@example.com