"b" Keeping Is Important
Why 83(b) filings should be part of the legal checklist
This week talking about something small companies may miss during the start-up phase but is important when moving toward providing equity grants to employees. Tax forms are not as exciting as other financial or start-up topics we normally cover but are still important to understand as it can impact both fundraising and future tax liabilities. As a disclaimer, we are not a CPA or law firm so nothing in this post should be considered tax, legal or any real advice. Our goal is to flag areas of importance for founders or executives to cover with their advisors.
It’s the day of your company’s IPO and as the founder you have spent the past hour doing several TV interviews. After years of hard work your equity in the company will vest in full upon the first public stock trade. Today is going to be life changing, as once the stock vests you will owe taxes for the full value of the shares, even though you are not selling anything.
What Happened?
83(b) happened. Or more specifically nobody realized the need to file an 83(b) with the IRS. While it would be almost impossible for a company to get to an IPO without tax advice, the example describes a worst-case scenario and why it’s important to have the right tax and legal advice when becoming an equity owner in your early-stage company.
83(b) In General
The filing tells the IRS you want to be taxed on shares when granted but not when vested, and then have the capital gains taxed only when a sale occurs. Within 30 days of receiving a stock grant, employees must mail an 83(b) to the IRS. Mailing is key as sometimes the IRS does not respond, so make sure to have verification of mailing.
What happens in the normal course of business is an 83(b) is filed within the 30-day period. As a founder you receive stock grants that vest upon the IPO and do not have to declare the value as income. You only pay tax when you sell the shares.
But what happened to our poor founder in the beginning example? Upon the IPO the stock started trading and shares vested in full. Suddenly the entire value of those shares must be declared as income in that year since no 83(b) was filed. Sale of the shares to cover the tax could be significant and have a material impact on the founder’s holdings, control of the company, and perception in the market.
It's Also Important For Fundraising
Most experienced VC’s in Series A or subsequent rounds will include the 83(b) filings as part of legal and financial diligence, as no VC wants a founders selling significant stock just to pay taxes. Reminder here for aspiring angel investors on why some basic legal and tax diligence matters. While none of this should be taken as tax or legal advice (we are not a CPA or law firm), the 83(b) should be one of many items for every founder’s checklist.