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What Is A Section 83(b) Election?

At its most basic level, a Section 83(b) election is an election to be taxed on property received in connection with the performance of services even though the taxpayer may not get to keep or may have to forfeit that property. For example, suppose you receive nontransferable shares of stock from your employer but they do not vest until you have provided 1 year of service. You could, if you wanted, wait to be taxed on those shares until 1 year passes. The problem with this approach? The shares might increase in value substantially over the course of that year and when the shares vest you may not be able to afford the taxes that become due on vesting. An alternative is available under Section 83(b) of the Internal Revenue Code. Under Section 83(b), even though you might not get the keep the property you received, or may have to forfeit it, you can elect to be taxed on your receipt of the property at the time you receive it, instead of waiting until it vests.

Section 83(b) Election

Under Section 83 of the Internal Revenue Code:

  1. a taxpayer who receives property in connection with the performance of services must generally recognize as ordinary income the difference between the value of the property and the amount paid in exchange therefor at the first time the property is either transferable or not subject to a substantial risk of forfeiture.
  2. Section 83 allows a taxpayer who receives property in connection with the performance of services that is subject to such restrictions (e.g., nonvested property) to elect to recognize this income at the time of transfer.There are a couple of benefits of a Section 83(b) election:
    • (i) the taxpayer avoids having ordinary income on vesting; and
    • (ii) the taxpayer starts the capital gains holding period.

For example, suppose a startup company founder is issued founders’ stock that is subject to a company repurchase at the stock’s cost, but the repurchase right lapses over a service based lapsing period.  This founder has received stock, but because the stock is subject to a substantial risk of forfeiture (the at-cost repurchase right lapsing over the service based vesting period), the founder does not have to pay tax on his receipt of the stock until it vests.  However, the founder may prefer to make a Section 83(b) election to pay tax on the value of the stock today because its value is lower than it is expected to be when it vests–or because the founder paid full value for it today, so the Section 83(b) election costs him no additional tax today.  The making of the Section 83(b) election also starts the founder’s capital gains holding period.

Frequently Misunderstood Points

If a founder receives shares that are fully vested–that is, not subject to an at-cost repurchase right that is lapsing over a service based vesting period–no Section 83(b) election is required.

It is a common misconception, but a Section 83(b) election generally cannot be made with respect to the receipt of a private company stock option.  You must exercise the option first and acquire the stock before you can make a Section 83(b) election, and you would only make a Section 83(b) election in that instance if you exercised the option and acquired unvested stock (if the stock acquired on exercise of the stock option was vested, there would be no reason to make a Section 83(b) election).

Another common misconception is that Section 83 does not apply to restricted stock that is purchased at fair market value.  This is not true.  Section 83 applies even to stock that has been purchased at fair market value, if the stock is subject to a substantial risk of forfeiture and received in connection with the performance of services.  See this case, Alves v. Commissioner.

An 83(b) election has to be filed with the IRS within 30 days of receipt of the property, a copy has to be filed with the tax return of the person making the election, and a copy must be provided to the company.

Additional information about making the election can be found Code of Federal Regulations.

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Alternative Minimum Tax (AMT)–What Is It?

The alternative minimum tax (the AMT), is an alternative tax regime Congress originally enacted to prevent high income taxpayers from not paying any income tax at all.  The AMT is calculated by first calculating regular, ordinary taxable income, and then adding to that tax base items excluded from the regular tax base to determine alternative minimum taxable income (AMTI).  Then, after an exemption amount is applied, AMTI is subject to a flat tax–whichever tax is higher, the ordinary income tax, or the AMT, the taxpayer owes.

Most importantly to early stage startup companies is this–that the spread on the exercise of an incentive stock option is an AMT adjustment.  Meaning, that even if the option was granted at FMV, so that there is no income on grant, nor ordinary income on exercise–there is potentially a dramatic AMT impact on exercise.  Beware!

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About Our Practice

About Our Practice

Startup and emerging companies need to move quickly. Market opportunities are short-lived and cash is generally tight. Entrepreneurs need lawyers who can handle the necessary fast pace and provide a range of services to meet the company’s evolving needs. Whether it be the simple act of formation, helping your company in its various growth stages or representing your company in a liquidity event – from an IPO to a multi-billion acquisition — Davis Wright Tremaine has the experience to help your startup or emerging company succeed.

About Joe Wallin

Joe Wallin, one of the editors of this blog, is a partner in the Seattle office of DWT. His practice encompasses a broad array of business transactions, including representing start-up companies in their formation and fundraising, representing venture capitalists in investments, and representing buyers and sellers in mergers and acquisitions transactions. He represents public companies with respect to their public filings and corporate governance matters. He also advises businesses and individuals with respect to tax matters involved in such transactions. Joe’s phone number is 206.757.8184.  He can also be reached at joewallin@dwt.com.  In addition, Joe has a well-maintained Avvo profile and is active on Twitter (@joewallin) as well.

About Stuart Campbell

Stuart Campbell, one of the editors of this blog, is a partner in the Seattle office of DWT. Stuart represents emerging technology and other high-growth companies, advising such clients with respect to their formation, seed, angel and venture capital financings, intellectual property matters and other legal issues they face. On behalf of emerging companies and venture investors, Stuart has handled over 150 angel and venture capital financings in the last decade. He also routinely represents buyers and sellers in mergers and acquisition transactions.

Stuart’s emerging company clients have included Big Fish Games, Tenzing Communications, Extend America and Clearwire Corporation. He has represented G.E. Capital, Eagle River Holdings, Mitsubishi Corporation, other institutional investors and numerous angels in making venture capital investments in emerging technology and other high growth companies.

Stuart’s phone number is 206.757.8017. He can also be reached at stuartcampbell@dwt.com.

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About Stuart Campbell

Stuart Campbell, one of the editors of this blog, is a partner in the Seattle office of DWT. Stuart represents emerging technology and other high-growth companies, advising such clients with respect to their formation, seed, angel and venture capital financings, intellectual property matters and other legal issues they face. On behalf of emerging companies and venture investors, Stuart has handled over 150 angel and venture capital financings in the last decade. He also routinely represents buyers and sellers in mergers and acquisition transactions.

Stuart’s emerging company clients have included Big Fish Games, Tenzing Communications, Extend America and Clearwire Corporation. He has represented G.E. Capital, Eagle River Holdings, Mitsubishi Corporation, other institutional investors and numerous angels in making venture capital investments in emerging technology and other high growth companies.

Stuart’s phone number is (206) 757-8017. He can also be reached at stuartcampbell@dwt.com

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