83(B) Election

83(b) election is a very sharp tool in startup founder’s shed. It allows for recognizing income from restricted stock at the time the stock is granted. Given all the complexity of this election, let’s try to explain it to a 5-year-old. Say, we put 5 empty boxes on the table and tell a child if he behaves, we’ll fill 1 box with between 1 to 100 candies a day. Thus, there’ll be 5 boxes full of candies on day 5. The only condition is he’ll have to share them with his friends anytime the box is full. This kid doesn’t like sharing so comes up with a tricky way to keep most candies. Instead of sharing with friends when candies are received, offers to share them today. The question is how many should be given to friends? The child offers to take the average number of 50 and gives half of that – 25 treats for each day a total of 125 candies. Now with basic calculation we can figure out that on day 5 for every box that will have less than 50 sweets the child will lose candies but for every box that will have more than 50 the child will keep more than expected. 83(b) does something similar with real money. To completely understand it, let’s get familiar with 3 words:

1.  Restricted Stock

2.  Granting

3.  Vesting

Restricted Stock

Most startups struggle to find financing and therefore cannot offer competitive pay to their employees. Instead, startups often offer stocks to employees. The problem is, what if the employee takes the stock and leaves on their day 2? Therefore, startup lawyers have come up with the notion of the restricted stock. It basically means the stock cannot be sold or can be forcibly bought back if or until certain conditions are met, typically an employee or an officer staying with the company. When restricted agreement is executed, the stock is typically granted to employee and the time when the restrictions expire is called vesting. For example, Kelsi is granted 100 units of restricted stock on March 1, 2023. For the next 5 years every March 1 that she stays with the company 20 units are vested. In the beginning she has 100 granted units and 0 vested. On year 3 she’ll have 60 units of vested stock. If she quits then, she will keep 60 units but forfeit on 40. On year 5 all 100 stocks will vest and she can keep them even if she quits. Let’s say the fair market value of the stock was $1 in 2023 then it kept changing so we have the following results:

So, any time restricted stock is vested, IRS considers it an income at the current stock value and the taxpayer will pay personal income taxes on it. Since there are many factors that can affect personal tax rates, we assumed a direct 50% tax rate. As a result, she paid a total $65 between 2023 and 2027.

Now, where does the 83(B) come handy? if the election is made, the profit from receiving stocks is recognized when the stocks are granted and not vested. So, in 2023 the taxpayer would recognize 100 stocks received at $1 fair market value resulting in $100 taxable income and $50 tax. In this case the election was clearly favorable but if the stock price goes down the taxpayer will pay more tax. The reason 83(b) election is so popular with startups is because of a very low stock value in the beginning of company’s lifecycle. The best case, the stock price will go up and the taxpayer will save money. The worst case it will stay the same - worth almost nothing and the taxpayer will not lose money.

Example

While there is no specific template of form offered by IRS, 83(b) election statement must mention the personal information of the taxpayer, the description and value of the asset, the name of the issuing company, the date of granting, the price paid for it. Given all the intricacies of restricted shares, a professional must be consulted before filing this form. The example below is for information only and should not be construed as a legal advice.

“The undersigned taxpayer hereby elects, pursuant to Section 83(b) of the Internal Revenue Code

of 1986, as amended, to include in his or her gross income the amount of any compensation taxable to

him or her in connection with his or her receipt of the property described below:

The name, address and taxpayer identification number of the undersigned are as follows:

NAME OF TAXPAYER: Kelsi J

TAXPAYER’S ADDRESS: Anatheidophobia Ln, Quaks, Idaho 10002

Tax Id: 123-45-6789

1. The property with respect to which the election is made is described as follows: 100 shares (the “Shares”) of the Common Stock of Dynamite Inc (the “Company”).

2. The date on which the property was transferred is: September 1 2023.

3. The taxable year for which the election is made is: 2023.

4. The property is subject to the following restrictions: 100 Shares may be repurchased by the Company. This right lapses over time.

5. The fair market value of the property is: $100.

6. The amount, if any, paid for such property: $100.

7. A copy of this form was provided to the Company.

Taxpayer Signature: Kelsi J 09/01/2023”