August 2012 - Accountalent

First, a few basics:

If you have stock options, you do not need to file an 83(b) Election Form, unless you exercised the option early.
If you purchased/received founder’s stock and there are no restrictions, such as vesting, you do not need to file an 83(b) Election Form.
If you purchased/received restricted stock in a growing startup, you should probably (about 99% of the time) file an 83(b) Election Form.

Here is why you want to file an 83(b) Election:

If you think the value of your stock will increase, you will NOT be forced to pay taxes on “phantom income” each year.

Let’s give an example to show the consequences of not filing an 83(b) election:

You own 10% of the stock of your startup. It vests over 4 years, or 25% per year.
You purchased this stock for $100 (fair market value) on January 1 of Year 1.
During Year 1, the Company raised some outside financing that values the company at $10M.
At the end of Year 1, the value of the Company is $10M and the value of your stock is worth $1M.
You have about $250K in taxable income in Year 1 ( [value of Company at year-end, $10M less value of Company at beginning of year, $1K] * ownership percentage, 10% * vesting % in Year 1, 25%).
You owe about $100K in Federal and State taxes.
You will pick up additional taxable income in Year 2 through Year 4 if the value of the startup continues to increase.
You do not get any tax relief if the value of the Company decreases.
Remember, this “phantom income” is triggered just by the value of the Company increasing – not by exercising the options or selling the stock.

Here is how to file an 83(b) election:

Download the Sample 83(b) Election Form and Letter below.
Sign the 83(b) Election Form and letter and follow the instructions in the letter.
Mail the letter and 83(b) Election Form to the IRS address (see dropdown below for address) within 30 days after the stock grant (there is no relief if you file late).
Mail Certified Return Receipt Requested to prove timely delivery.
If you live in a community property state, your spouse also needs to sign the 83(b) Election Form.
Give a copy of the signed 83(b) Election Form to the Company.

SAMPLE SECTION 83(b) ELECTION FORM:

SAMPLE TRANSMITTAL LETTER TO IRS:

Enclosures

WHERE TO MAIL THE LETTER AND 83(b) ELECTION FORM TO:

Before mailing, check the IRS instructions for Form 1040 and/or consult your tax advisor to ensure the addresses below are still valid as the IRS occasionally changes mailing addresses.

If you live in…	Mail to:
Alabama, Arkansas, Connecticut, Delaware, District of Columbia, Georgia, Illinois, Indiana, Iowa, Kentucky, Maine, Maryland, Massachusetts, Minnesota, Missouri, New Hampshire, New Jersey, New York, North Carolina, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Tennessee, Vermont, Virginia, West Virginia, Wisconsin	Department of the Treasury Internal Revenue Service Kansas City, MO 64999-0002
Arizona, Florida, Louisiana, Mississippi, New Mexico, Texas	Department of the Treasury Internal Revenue Service Austin, TX 73301-0002
Alaska, California, Colorado, Hawaii, Idaho, Kansas, Michigan, Montana, Nebraska, Nevada, North Dakota, Ohio, Oregon, South Dakota, Utah, Washington, Wyoming	Department of the Treasury Internal Revenue Service Ogden, UT 84201-0002
A foreign country, U.S. possession or territory,* or use an APO or FPO address, or file Form 2555 or 4563, or are a dual-status alien.	Department of the Treasury Internal Revenue Service Austin, TX 73301-0215
*If you live in American Samoa, Puerto Rico, Guam, the U.S. Virgin Islands, or the Northern Mariana Islands, see Pub 570.

IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Smartco Corp is a 2-year old startup that recently started selling product to a few large customers. They have 30 employees and a $250K monthly payroll.

Recently, Smartco ran into a serious cash flow problem due to a late-paying customer.

Most startups will experience cash flow problems. They often rear their ugly head when the business just becomes cash flow positive and is no longer living off investor life support money. For many companies, especially if the investors and owners are tapped out after a long development stage, it can be the final straw.

Smartco was exactly at that juncture. Many years and millions of dollars to develop the product had finally come to an end. They had real customers and a working product. Cash flow was tight, but improving when a major customer went south on a large receivable that jeopardized Smartco’s future existence.

Like many tech startups, most of Smartco’s expenses were payroll. They did not want to lay off employees, though, but needed a temporary 20% reduction in payroll cost to survive.

Luckily, Smartco was located in a state (such as MA and about 25 other states) that have a Work Share program. These programs let a business reduce the hours of certain or all workers and allow the employee to collect Unemployment Compensation from the state for the hours cut.

So, Smartco temporarily reduced everyone’s pay to 4 days. They remained open 5 days, as they are able to dictate what day each employee can take off. Some of the hourly and lower paid employees actually received most or their entire regular payroll, as overtime plays into the benefit calculation. All of Smartco’s employees, though, were happy to collect for the other day and spend it skiing or at the beach.

The details of these Work Share programs vary by state, but can be incredibly valuable in retaining employees while going through cash flow problems. Recently, Congress passed a bill that federally funded these programs, so most states currently without a Work Share program will probably implement one soon.
______________________________________________________________________
IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Month: August 2012

83(b) Elections For Dummies