Frequently Asked Questions
What is a Section 83(b) election?
It is a provision under the Internal Revenue Code in which the founder(s) informs the IRS that he/she would like to be taxed on his equity on the date the equity was granted to him, rather than on the date the equity vests. It gives him/her the option to pay the taxes on it immediately rather than waiting to pay taxes at the time the shares vest.
How do I make an 83(b) election and what internal processes are involved?
In the minutes of a Board of Directors meeting there should be mention of the granting of stock options and when they vest, what the fair market value (FMV) will be, etc.
There should also be an agreement from the corporation given to the individuals that are being granted the stock options with all the term spelled out. It prevents corporations from giving stock to shareholders at a reduced price and claim that they had an 83(b) election so they will not have to recognize any taxes at the inflated price.
Within 30 days of the grant a letter must be sent to the Internal Revenue Service indicating to them that you are electing 83(b) or the IRS will reject any 83(b) election that is not postmarked within 30 days of the grant. No Exceptions.
What is the cost to grant stock options with my business tax return?
Normally, a few hundred dollars, but it could go higher depending on the complexity.
When should I grant stock options with my business tax return?
You can grant the stock options whenever you want. It has no tax effect on the corporation as the tax is paid by the shareholders.
What is an example of what my tax situation will look like with and without an 83(b) election?
Without an 83(b) election:
You are granted an option to buy 100 shares of stock worth $1 today in 3 years. No taxable event has occurred. In 3 years, the stock is worth $10, and you exercise the option to purchase the 100 shares for $100. You must recognize $900 of ordinary income and pay tax at a maximum rate of 37%. Your basis when you sell the shares in the future will be $10/share or $1,000 total.
With an 83(b) election:
You are granted an option to buy 100 shares of stock worth $1 today in 3 years. You pay tax today on $100 at 37% (max) for the 100 shares that you were granted. When the stock vests and you exercise your option, you do not pay any tax. You only pay tax when you sell the shares in the future. Your basis would be $1/share or $100.The advantage is that you would be taxed at a preferential rate of 15$
In what case would I make an 83(b) election?
An 83(b) election is optional and only applies if stock options are going to be granted. It has restrictions that will vest sometime in the future.
For example, let’s say you purchased corporate stock in exchange for cash and/or property. The basis of the stock you received is the fair market value (FMV) of the property you contributed. When you sell that stock you will be taxed on the difference of the selling price of the stock and what you paid for it. So, if you bought the stock for $1 and sold it for $100, you would have a capital gain on the sale of $99. When you sell the stock it is a taxable event, and you would pay tax on the gain of $99. In the US, there are preferential tax rates for investments that are held for more than 1 year. You would be taxed at 15% if you held the stock for more than 1 year, so about $15.
The purpose of an 83(b) election is to defer the recognition of tax to a future date. The company will grant you the right to buy shares in the future at today’s FMV. Without an 83(b) election, if you are granted stock rights that vest in the future it is a non-taxable event. When you exercise the option to buy those shares you recognize taxable income that can be taxed at a rate as high as 37%. Then, the basis of the stock is your purchase price and the amount you recognized as gain for when you sell the stock in the future.
With an 83(b) election, you recognize income on the date of the grant for the FMV of the grant. When you exercise the option to purchase those shares in the future, you pay no tax. The tax is deferred until you sell the shares.
Is an 83(b) election a requirement when filing my business taxes?
No, an 83(b) election is not a requirement; it is optional.