83(b) Elections and the Smaller Business

We continue our series of articles on compensation with this blog on IRS Section 83(b) elections.

A section 83(b) election allows an employee or contractor to include in taxable income the fair market value of property they received for the performance of services before they are truly entitled to that property.  With small businesses, this often occurs with restricted shares granted to employees or contractors that vest over time.  The election does not apply to stock options.

Without the election, with shares that have yet to vest and which the recipient can’t transfer, the fair market value of those shares is included in income when either the shares are theirs or the shares become transferable.  Generally, that means as the shares vest.

The 89(b) election allows the recipient to recognize all the income associated with all the shares at the date of grant, presumably at a lower value.  For tax purposes, all shares are treated as if they are fully vested.

If share value is expected to rise over the vesting period, electing 83(b) is a smart choice.  The election starts the clock for capital gain recognition should the shares be sold or transferred in the future.  It also determines that taxable basis for these shares when later sold or transferred.

Electing 83(b) should not be considered a slam-dunk.   Even with a start-up, shares have value.  This may be influenced by venture capital investments or other equity funding occurring at the same time as the restricted shares grant.  And it is quite possible that when the shares do vest, their value may be lower than at the time of grant.  Lastly, an employee who leaves prior to the completion of the vesting period will have paid taxes on compensation never fully received.

An 83(b) election is smart if the amount of income reported at grant is small, the share value’s growth prospects are moderate to high and the risk of share forfeiture through employee termination is very low.

An 83(b) election must be supported by a valuation of the shares in question.  JBV has significant experience and expertise in that area.

A tax specialist should assist with the election to avoid any tax consequences.

At JBV, we are here to assist you.