All posts tagged taxes

Where Do I File My 83(b) Election?

Where Do I File My 83(b) ElectionIf you have never filed a Section 83(b) election before, you might not know where to file it.

Increasingly, founders come to me who have been filing their Forms 1040 electronically. Many of these founders have never filed paper returns, and when I tell them they have to file the 83(b) election with the office of the IRS at which they file their returns, they don’t know what I am talking about. Because they haven’t been mailing in their Forms 1040, they don’t know where to file a Section 83(b) election.

They say to me: “I have e-filed the last few years so I actually don’t have an address when I look at my returns.”

The IRS Regulations make clear where you are required to file the 83(b) election.  They provide as follows:

“The election referred to in paragraph (a) of this section is made by filing one copy of a written statement with the internal revenue office with whom the person who performed the services files his return.”

If you don’t know where to find the physical address, you can refer to the instructions in Form 1040.

You can find these instructions at www.irs.gov/pub/irs-pdf/i1040.pdf. At the time of this blog post, the places to file were found on page 104.

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Is the QSB Stock Tax Exclusion Even Worth It?

QSB stock tax exclusion1In the throes of the end of last year, when people were trying to figure out whether to incorporate a C Corporation before year end to try to set themselves up to qualify for the Section 1202, qualified small business stock 100% exclusion from tax benefit (subject to a $10M cap), I heard the following claim made:

“You can only exclude 10x your basis in your stock. Thus, if you are a founder, and your basis in your stock is very, very low–the exclusion isn’t worth much.”

If the above statement was true, the Section 1202 exclusion for qualified small business stock would indeed not be much of a benefit for founders, who typically don’t have a large cost basis in their shares.

Most founders might pay just a few thousand dollars for their founder shares. If a founder paid $2,000 for his or her shares, and the most they could exclude from tax was 10x that, the exclusion would only shelter potentially up to $20,000 in income from tax.

If you could only exclude 10x your basis in your shares from tax, Section 1202 would indeed be a meager prize.

But is the above statement true?

No.

Section 1202 reads as follows:

(b) Per-issuer limitation on taxpayer’s eligible gain

(1) In general

If the taxpayer has eligible gain for the taxable year from 1 or more dispositions of stock issued by any corporation, the aggregate amount of such gain from dispositions of stock issued by such corporation which may be taken into account under subsection (a) for the taxable year shall not exceed the greater of—

(A) $10,000,000 reduced by the aggregate amount of eligible gain taken into account by the taxpayer under subsection (a) for prior taxable years and attributable to dispositions of stock issued by such corporation, or

(B) 10 times the aggregate adjusted bases of qualified small business stock issued by such corporation and disposed of by the taxpayer during the taxable year.

For purposes of subparagraph (B), the adjusted basis of any stock shall be determined without regard to any addition to basis after the date on which such stock was originally issued.

Thus, you get the greater of 10x or $10M. Rest assured founders, the benefit is ample if you qualify.

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Stock Option Exercise Tax Math

Stock Option Exercise Tax MathExercising a stock option is not always as straight forward as you might expect. The reason? Taxes.

How to Calculate the Tax on the Exercise of an NQO

“Spread” means the positive difference between the fair market value of the stock underlying the option and the strike price.

Let’s do a math example. Suppose you have a nonqualified stock option to purchase 50,000 shares at a strike price of $0.05 per share. The current fair market value of the common stock is $3.75, according to the company’s latest Section 409A calculation. Meaning, the spread is $3.70 a share.
If you exercise your option in full, you will have to write a check for 50,000 x $0.05, for the strike price – for a total of $2,500.

However, when you exercise a nonqualified stock option, not only do you have to pay your employer the exercise price per share, but you also have to pay your employer the employee tax withholding due. This includes your income tax withholding and employee side FICA.

Thus, you will also have to pay the company an amount equal to the income tax and employee‑side FICA tax withholding on the spread. The “spread” here is 50,000 shares x (3.75 – 0.05), or 3.70 per share x 50,000, or $185,000. Income and employee‑side FICA on $185,000, assuming you are over the FICA cap, is going to be approximately $48,932.50. (This according to Randy Harris, payroll consultant (@getthepayroll). Thank you, Randy!, calculated as follows:

    $185,000 x 25% (supplemental withholding rate for pay under $1 million) = $46,250
    $185,000 x 1.45% (Medicare tax) = $2,682.50
    $46,250 + $2,682.50 = $48,932.50

But watch out, annual earnings over $113,700 will be exempt from the Social Security Tax of 6.2% BUT due to the Affordable Care Act, as of January 1, 2013, income over $200,000 will require an additional 0.9% Medicare Tax Withholding.

In addition, please see the attached link for a breakdown of tax rates applicable to other situations, and be sure to consult your accountant/advisor for specifics:  2013 Fast Wage & Tax Facts.

Finally, also be aware that this tax withholding satisfies the employer’s obligations, but may not satisfy the employee’s tax obligations in full. That depends on the employee’s other tax items. The employee may need to make additional tax deposits to avoid an underpayment penalty. The optionee should consult with his or her own tax advisor on this issue.

State Income Tax Consequences

This blog post doesn’t address potential state income tax withholding issues.

Conclusion

When you are planning to exercise, consult your company’s chief financial person. He or she can help you work through the tax math of the exercise.

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