When an individual receives equity in a company as compensation they must pay taxes on it. The tax liability is calculated at an income tax rate based on the fair market value of the equity at the time it was given to the individual. When the tax is due depends on when the equity is received. For example, when the equity compensation is subject to a multi-year vesting agreement, an individual does not pay tax on the equity until it vests. The tax due is calculated based on the fair market value of the stock at the time the stock vests. If the company’s stock increases in value over the vesting time frame, the individual will increasingly pay more over time.
How to Make an 83(b) Election
The 83(b) election allows an individual to be taxed for the entire amount of equity that will vest based on the value of stock at the time it is granted. To make the election, you must send a letter to the IRS within 30 days of the grant of the stock. Your accountant can assist you with this letter or a sample letter can be obtained from the IRS website.
When to Make an 83(b) Election
An example of when an 83(b) election would be beneficial is when there is a multi-year vesting agreement in a start-up company which has very little value at the current time, but the value of the company stock is expected to increase over the vesting time frame. Tax would be paid on the entire stock compensation when the value is very low. No additional taxes are due on the equity until you liquidate it. If the liquidation date is over a year from the equity grant date, taxes are calculated at the long-term capital gains rate.
When Not to Make an 83(b) Election
An individual might not want to make an 83(b) election when they have received equity in a company with a high valuation and have concerns the value may not continue to increase or might decrease over the vesting time frame.
In conclusion, consider the initial value of the company at the time the individual is compensated and which direction the stock value is expected to go when deciding whether or not to make the 83(b) election.
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