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An 83(b) election is a powerful tax planning tool for founders, employees, and executives with stock-based compensation. This election allows individuals to pay tax on unvested shares now, instead of when the stock vests, accelerating tax instead of deferring it. The main reasons to consider an 83(b) election are to minimize taxable income and control the timing of it. This strategy is beneficial for those with stock options, founders shares, or restricted stock.
Section 83(b) of the tax code provides individuals with the ability to accelerate taxation of their equity grant. Normally, equity-based compensation is subject to vesting requirements, but in certain cases, it is advantageous for the taxpayer to recognize income before the stock vests. Making an 83(b) election allows individuals to pay tax on the taxable spread at grant instead of when the stock vests. This election can be made for restricted stock or in conjunction with an early exercise for stock options, with any subsequent taxation deferred until the stock is sold.
Startup founders, early employees, executives, and other service providers can make an 83(b) election. The types of unvested stock compensation eligible for this election include restricted stock, founders shares, incentive stock options, non-qualified stock options, and profits interests in an LLC or partnership. It is crucial to adhere to key deadlines for filing the election, which is 30 days from the grant for restricted stock and 30 days from exercise for stock options.
There are three key benefits of an 83(b) election. First, it has the potential to minimize tax, particularly when the taxable spread is low. Secondly, it starts the clock on tax-favorable holding periods. Lastly, it provides individuals with more control over their tax situation and equity. Making this election can help avoid cash flow and tax issues in the future, especially for fast-growing startups.
Before making an 83(b) election, individuals should consider several factors. These include the risk of the stock not increasing in value, vesting requirements, the possibility of changes in holding periods due to various events, and cash requirements for early exercising. A simplified hypothetical example illustrates the benefits of making an 83(b) election when early exercising non-qualified stock options, resulting in significant tax savings compared to not making the election.
In conclusion, long-term planning with stock compensation is essential for individuals with stock-based compensation. It is crucial to think strategically and work closely with financial and tax advisors to make informed decisions. While an 83(b) election can be a valuable tax planning tool, individuals should consider all aspects of their financial situation, risk tolerance, and goals before making this decision.
