Blog Article

Consider an 83(b) election for your new vesting agreement

Stock Market Analysis Abstract

By Merriman Wealth Management, Wealth Advisor
Published On 02/24/2015

In the start-up world, founders create a company and hire a business attorney to compile incorporation documents. Once the company is formed, if the founders elect to vest into their ownership over time, the attorney will send the founders a reminder email saying, “Don’t forget to file your 83(b) election! You have 30 days to make this happen.” Then a week later, the founders receive another reminder email, and maybe a few more down the road, but they let the chance to file the election pass on by.

So what is all the fuss about?

The 83(b) election is often forgotten or ignored at the critical moment when a startup begins to gain traction. Or, an employee who obtains a stock vesting agreement for the first time can easily miss it. When used wisely and in the right situation, the 83(b) election can be invaluable.

What is it?

The 83(b) election is available in stock compensation agreements with a substantial risk of forfeiture (a.k.a., restrictions). This is usually seen with stock vesting agreements for founders and executives of newly created companies and does not apply to phantom stock (RSUs, phantom units, etc.). Rather than paying tax each year upon vesting, this election allows you to pay all taxes up front based on the value of the stock at the time of award/grant. Then, when you dispose of your stock years later, you will be subject to capital gains tax rates.

When does it make sense?

It makes sense when you are a founder of a new company and agree to a long-term vesting agreement, or an employee with an at-the-money stock option agreement allowing for early exercise.

At the formation of a technology company, the value is often much lower than the expected future value. Paying ordinary income taxes on the present value of your stock agreement may mean a much lower tax liability. In addition, if you expect the company value to increase and your salary and bonus to increase, your future tax rate may be higher, making the low tax cost of an 83(b) election at initial award beneficial. Stock in companies with very low valuations generally makes sense for applying the 83(b) election.

You can find an example of the tax implications here.

So when does it not make sense?

Executives signing on with a company at a later stage or executives receiving new stock vesting agreements with a substantial difference between grant price and stock price will need to weigh the consequences.

  • If the stock price fluctuates over the vesting period, you may pay a larger tax liability if the price is higher at grant and the stock decreases in value as it vests over time.
  • Consider liquidity – do you have cash to cover the additional tax bill and is it the best use for your cash?
  • If you make an 83(b) election and the stock price decreases substantially, this is a non-recoverable tax payment to the IRS and you may be forced to take any liquidated stock losses over a period of time. Please consult with your tax accountant to understand the full consequences.

The decision to make an 83(b) election can be difficult. Executives and founders of new companies are excited for the future and truly value the company close to heart. It is difficult to remove yourself emotionally from valuing the company, deciding on whether to make an 83(b) election, and to really understand the overall statistics for the tech sector. If you want to make this election, consult with your tax advisor to ensure you notify and file with the IRS and the company you have the agreement with in the proper time period, and that an appropriate valuation method is used.

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By Merriman Wealth Management, Wealth Advisor

At Merriman, we manage your wealth so you can lead your best life. We take care of the financial planning and investment management, so you can deal in more possibilities and have the space you need to dream big.

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