Planning for Executives - 3 Advantages and disadvantages of Section 83(b) elections in option strategies Flashcards
What is an 83b election?
-The 83(b) election is a provision under the Internal Revenue Tax Code (IRC) that gives an individual the option to pay taxes on the total fair market value of the restricted stock at the time of granting.
-applies to equity that is subject to vesting.
Under what circumstaces would someone file a 83(b) election?
- the individual expects the stock value to increase
- the employee expects to work for the company long-term
- only for ESOs and restricted stocks
- Generally, an 83(b) election should be considered if the outlook of the stock is bullish over the vesting period.
- The individuals electing 83(b) believes that their tax bracket is lower at the time of election than in the future,
What is a purpose of filing a Section 83(b) election?
The 83(b) election creates the opportunity to pay taxes on the equity upfront before the vesting period starts. This tax strategy allows the co-founder to only pay taxes on the fair market value of the shares, minus the cost of exercising the options.
What are the advantages of Section 83(b)?
- Making an 83(b) election means that you’re able to pay income taxes earlier, often before your company shares have had the opportunity to appreciate in value.
- Under the right circumstances, making an 83(b) election can significantly reduce your tax liability on a stock award.
What are the disadvantages of Section 83(b) in the employee’s standpoint?
- pay ordinary income tax on the fair market value of the property in the year she receives the stock or other
property - if employees leave before the vesting period or if the stock value depreciates, then they would have paid taxes on shares that were never received.
What are the downsides to filing for an 83(b) election in the employer’s standpoint?
- Vesting restrictions can make benefit appear abstract to employees
- company unable to take tax deduction for the value of the gain employees realize with 83(b) election
- subject to variable accounting rules. requiring changes in value be charged as compensation expense
- new compensation deduction limit of $1 million for top 5 earners including CEO and CFO
What are not considered substantial restrictions?
(1) a consulting contract with a retiring executive that called for only
occasional services at the executive’s discretion
(2) a requirement that an employee must return the property
if he commits a felony
(3) a noncompetition provision
(because this is largely within the employee’s control).
What sort of plans can you file an 83b election for?
ESOs and restricted stocks
What is the timeline to file an 83(b) election?
within 30 days of the initial grant of the stock
How does tax minimization work for 83(b) election?
—Restricted shares generally taxed at ordinary income rates at
vesting
—Investor chooses to recognizes income earlier in order to effect
future sale at LTCG rates
—Decline in stock price can produce significant losses
83B is a ____________ savings strategy - must be specified by plan document
Tax
In 83B an investor exercises stock options prior to _____________
vesting
What is an 83(b) election?
Tax saving strategy - must be specified by plan document
How long is the election for 83B?
30 days
Depict some impacts of 83B on stocks and taxes?
Stock subject to control and resale restrictions until vesting
* Opportunity to reduce taxes on bargain element with 83(b) election
―NSOs: tax on bargain element
―ISOs: AMT liability
* Decline in stock price can produce significant losses
16
