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September 22, 2015

Section 83(b) Election Tax Benefits for Startups

What is a Section 83(b) election?

An 83(b) election allows an individual, such as a startup founder or employee, to include the fair market value of property related to the performance of services as income.  The election essentially allows an individual to elect to be taxed at the time the property is received, as opposed to waiting until fully vested.

Why file a Section 83(b) election?

At first glance, an 83(b) election seems counter-intuitive as it accelerates income into a year where income would not otherwise be recognized.

However, this election can prove beneficial in a situation where the difference between the fair market value and the purchase price of the property is nominal.  In this scenario, little or no additional income would be recognized as a result of the election.  Having this election in place, especially at little or no cost, mitigates the risk of owing considerable taxes as result of a significant increase in the fair market value of the property received.

Filing an 83(b) election also allows the individual’s capital gains holding period to start.  In other words, the election “locks in” the ordinary income in the year of the election (the difference between the fair market value and the purchase price).  Any subsequent gain would receive favorable capital gain treatment.

Why not file a Section 83(b) election?

Accelerating income and “prepaying” tax is not without risks.  In a scenario where the fair market value of the property would decrease, it is possible that the individual would have recognized income unnecessarily.  Any tax paid as a result of the election would not be refundable.

How is a Section 83(b) election made?

For an 83(b) election to be valid, it must be filed with the IRS within 30 days after the purchase date.  There are no exceptions to this filing rule.

As you have probably gathered, the decision of whether or not to file an 83(b) election can be very complex.  For more information, please contact an Anders tax consultant.

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