Here’s some election news that doesn’t involve politics. An important development for tax planning with equity compensation emerged in mid-October at the annual conference of the National Association of Stock Plan Professionals (NASPP) in San Francisco. During a conference session that I attended, a staff lawyer with the IRS Office of Chief Counsel revealed that the agency is finalizing an official IRS form for the Section 83(b) election.
For those concerned about IRS tax filings and rules, this is a very big deal. There are various scenarios with equity compensation—specifically restricted stock, stock options, and LLC interests—in which making a timely Section 83(b) election with the IRS can be an important move for tax planning and minimization. However, currently no official IRS form exists for making that election.
Three Scenarios Involving The Section 83(b) Election
Below are three situations in which a Section 83(b) election is an action to consider.
Grant Of Restricted Stock
Grants of restricted stock are made by public companies and by private companies in the early startup stage (sometimes called founders’ stock). When you receive a grant of restricted stock, the grant must vest before you own the shares. Normally, the value of the grant is taxed at the time of vesting. However, you can instead choose to pay tax on the value of the stock at grant (minus anything you paid for the stock) by making a Section 83(b) election with the IRS within 30 days of the grant date.
Essentially, by making the 83(b) election you are betting that the stock will appreciate substantially between grant and vesting, so you choose to be taxed on what you hope will be the lower value at grant. Additionally, you make an early start on the one-year holding period you must meet to be taxed at the long-term capital gains rate (lower than the short-term rate) when you sell the shares.
Alert: The 83(b) election is not available for restricted stock units (RSUs).
Early-Exercise Stock Options
For employees in private companies who receive early-exercise stock options, i.e. options that can be exercised before vesting, an 83(b) election within 30 days of exercise is needed to change the regular tax treatment. You essentially purchase restricted stock with the same vesting schedule that the options had and pay taxes at exercise on any income from the spread (i.e. the difference between the stock’s fair market value and the exercise price). You also get an early start on the holding period for long-term capital gains.
LLC Interests
A limited liability company (LLC) has membership interests rather than shareholders. It can make equity-compensation-type grants in the form of profits interests or capital interests. Profits interests are more common, particularly for private-equity-backed companies.
Depending on how the grants are structured (a complex topic beyond the scope of this article), most tax professionals recommend an 83(b) election within 30 days of grant. With the right structure, these interests often have zero value at grant—i.e. no taxable income at that time—and long-term capital gains tax treatment at sale when the interests are held long enough.
Timing Of 83(b) Election Is Crucial
To be valid, a Section 83(b) election must be mailed to the IRS within 30 days of the grant date for restricted stock and LLC interests or the exercise date for early-exercise options. You send it by certified mail (return receipt requested), postmarked within that 30-day period, to the IRS Service Center where you file your tax return.
Currently, however, the IRS does not have an official form for the 83(b) election. You make the election in correspondence to the IRS that you or your tax advisor prepare, including all of the required information as indicated by guidance from the IRS. You also give a copy to your company.
This approach increases the risk of improperly filing the election or missing the deadline, which would make it invalid. Once the 30-day window has elapsed, you can’t make the 83(b) election to be taxed at the earlier time—with painful tax consequences should the underlying equity’s price later surge.
83(b) Election Carries Risks
The Section 83(b) election has risks. Once you have made the election and paid taxes, you cannot get those taxes back from the IRS if your employment ends before vesting or the equity becomes worthless. Should one of those outcomes occur, you may end up paying taxes on income that you never receive!
Moreover, unless you can prove to the IRS that you made a “mistake of fact” (very difficult to do), it’s almost impossible to revoke an 83(b) election after the initial 30-day election window of time. Therefore, you should speak with a tax professional (CPA, Enrolled Agent, lawyer) to be sure you understand how and why you are making this tax election.
New IRS Form Will Make 83(b) Election Much Easier
The welcome new Section 83(b) election form, expected to be IRS Form 15620, will be available as a downloadable PDF with fields for all the required information. I discovered that this new tax form is already listed in the long document table in an early September IRS notice on various topics published in the Federal Register.
At first, the form will be mailed to the IRS, but under the IRS modernization program it will eventually be submissible by e-filing. The new form is far along in its development, I was told in a separate discussion with my IRS source, and it may be released this year.
See myStockOptions.com for more details on taxation, planning, and risks with the 83(b) election and on early-exercise stock options in startup/pre-IPO companies.
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