Year: 2016

Just Filed my 83(b) Election Form – What Happens Next?

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If you just mailed your 83(b) Election Form to the IRS, do not expect anything to happen. The IRS does not acknowledge receipt or send you any correspondences regarding the filing.

In order to prove timely filing, you should always mail the form using US Postal Service Certified Mail with a Return Receipt requested. If you have never done this, just go to your local Post Office and ask the postal clerk. Here is a good instructional video http://www.wikihow.com/Send-Certified-Mail-(USA)

Make sure you keep the receipt that will be stamped with the mailing date and as a secondary backup, scan it and securely save it electronically. If you need to prove timely filing, there’s a strong chance it will be many years later. The IRS will always accept Certified Mail as proof of timely delivery.

Once the IRS receives the mailing, they will sign the Certified Mail’s Return Receipt and mail it back to you. This will show only that the IRS received it. The form needs to be mailed (not received by the IRS) within 30 days of the grant date.

As discussed in our “83(b) Elections for Dummies” post, in addition to mailing the form using Certified Mail, be sure to:
• Enclose a letter
• Include a copy of the 83(b) Election Form
• Include a self-addressed stamped envelope
In the letter, ask the IRS to date stamp the copy of the 83(b) Election Form, enclose it in the attached self-addressed stamped envelope, and mail back to you.

Following these instructions is crucial because if the IRS challenges your 83(b) Election Form when you sell the stock and the IRS did not properly record your 83(b) Election Form and you have no proof of timely filing, you lose.

Do I Need to File an 83(b) Election Form?

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There is no requirement to file an 83(b) Election Form. By default, the IRS assumes that you have not filed it.

The IRS taxes Restricted Stock (stock that vests over time) using a “pay me now or pay me later” method. By filing an 83(b) Election Form, you are telling the IRS that you want to pay them now. The IRS requires that you put this in writing and mail them the form within 30 days of signing the stock grant.

The form tells the IRS that you will include the difference between the fair market value of your Restricted Stock minus the amount that you paid for this stock as taxable income on your personal income tax return in the year of the grant.

Keep in mind, the fair market value is not reduced by the fact that the stock vests over time.

If you are granted your Restricted Stock shortly after the Company is incorporated, the fair market value is very low and you do not pay much for the stock. So, the amount that you include as taxable income on your personal income tax return is probably $0. If you pay nothing for the Restricted Stock, the amount reported as taxable income is the small difference between the fair market value and the amount paid ($0) for the Restricted Stock.

An 83(b) Election Form typically works best early in the Company’s life cycle when the valuation is low. If the valuation is high, say due to a financing, and the Company requires payment for the Restricted Stock, you may not have the available funds to purchase the stock. If they grant it to you for $0, then you need to include the difference between the fair market value of the Restricted Stock and the amount that you paid ($0) as taxable income. You would then pay income taxes on this amount and the amount of taxes may be significant.

What Happens If You Do Not File an 83(b) Election?

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There is no requirement to file an 83(b) Election Form.  By default, the IRS assumes that you have not filed it.

The IRS taxes Restricted Stock (stock that vests over time) using a “pay me now or pay me later” method.  By not filing an 83(b) Election Form, you are telling the IRS that you want to pay them later.

The best way to explain this is to use an example:

In 2016, you cofound a startup and are immediately granted 1M shares of Restricted Stock that vests over four years.  The fair market of the stock is $100 and you pay $100 for the stock.

During 2016, the startup does a financing and the valuation soars. Your 250K shares that vest at the end of 2016 are worth $1M.  Because you did not file an 83(b) Election Form, you need to add $1M of taxable income to your 2016 tax return and pay about $400K in taxes.  For the next three years, you will need to make the same calculation for the stock that vests during those years.

Assume the value of the startup does not increase over the next three years.  Each year, the 250K shares that vest are worth $1M and this amount is added to your taxable income.  So, you will have paid about $1.6M in taxes over the four-year vesting period.

The amount of taxable income that you recognized ($4M – $1M per year for four years) is added to your “basis” in the stock.  So if you then sold the stock for $5M, your taxable gain would be only $1M and you will pay about $300K in taxes.

If an 83(b) Election Form was filed, you would have paid no taxes during the vesting period.  If you then sold the stock for $5M, your taxable gain would be $5M and will pay about $1.5M in taxes.

As you can see, the IRS gets their taxes either way.

 

What is an 83(b) Election?

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An 83(b) Election Form is a written statement to the IRS telling them that you have been granted Restricted Stock from a Company where you will be providing services (employment, consulting, etc.). There is no official IRS form – it is just a written statement that contains information about the stock grant.

The purpose of the 83(b) Election Form is to inform the IRS that you want to report the difference between the amount that you paid for the stock and the fair market value of the stock (at the grant date) as taxable income on your personal income tax return. So, if you just incorporated, the value of the stock is very little – typically the par value of the stock.

Here is an example – you are a co-founder of a newly incorporated startup and you and your co-founders are each granted 1M shares of common stock, par value $0.0001 in 2016. You each pay $100 for your stock, which represents fair market value, as the Company just incorporated. The stock vests over a few years (the vesting makes it “restricted” stock).

So, the 83(b) Election Form informs the IRS that you received the 1M shares of Common Stock and the fair market value was $100 and you paid $100 for the stock. Thus, you are telling the IRS that you will report $0 ($100 minus $100) as taxable income when you file your 2016 personal income tax return.

The 83(b) Election Form must be mailed (cannot be e-filed) to the IRS within 30 days of the stock grant date. There is no relief if you miss the 30-day deadline and there is no extension available.

These Five Things Will Land a Startup Founder in Jail

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  1. Not remitting payroll taxes. “Cash flow is tight and a financing is just around the corner – I will just pay my employees their net pay and remit the withheld taxes and employer taxes when we close the financing (it is imminent) – it is worth the IRS penalty.”  You know what happens next.  This is a criminal offense.  You are actually stealing from your employees – the money you should have remitted belongs to them. This type of crime is taken very seriously, as it should be and can land you behind bars.

 

  1. Falsifying Financial Statements. You need accurate financial statements for a potential investor and they need to look good.  Do not even think of falsifying them – your financial statements are what they are.  This is “cooking your books,” and it is fraud and it is stupid.  It can be criminal – certainly a career killer, also.

 

  1. Not securing Workers Compensation Insurance. Workers Comp pays your employees 2/3rds of their pay if they are injured on the job and cannot work due to this injury.  Most states require this coverage and will fine you dearly if you do not have coverage.  Example: NY penalty is $2K for each 10-day period without Workers Comp.  This is a criminal offense and will probably bankrupt the Company because the injured employee will have a claim for this benefit against the Company.

 

  1. Not remitting or charging sales tax. Collecting sales tax from customers and not remitting to the state is similar to #1 above.  It gets trickier, though.  Often, a startup expands quickly and their activities in other states trigger a legal requirement to charge sales tax.  They do not know they have this requirement until they are audited. States are very smart about finding you, even if you have not registered in their state.  Even though you did not charge and collect sales tax, you are still treated as if you charged, collected and did not remit the sales tax to the state.  Again, a criminal offense.

 

  1. Hiring foreigners. Hiring a foreigner with the proper visa to legally work in the US is fine.  Often, though, startups will hire engineers that are attending or just recently graduated from a US college or university.  Often, there are restrictions on working off campus and it is the responsibility of you, the employer, to ensure they are legal to work in the US.  This can be criminal, and government audits for these infractions are on the rise.

So You Sold Your Startup for $50M – Why You Netted $19M, and How You Could Have Netted $32M

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Congratulations! This is it. Every entrepreneur’s dream is now your reality. You built your business from scratch and now, after 2 years of hard work, you’ve been bought out to the tune of $50 million.

Don’t pop the champagne just yet. Somehow, your shareholders are only receiving $20 million from that $50 million sale – less than half of what your business was acquired for. What happened? Did the Brinks truck driver decide that this was his time to make a break for it down to Mexico? Did someone take a pen and some white-out and change the “5” to a “2” before your check made it to the bank?

No, it was taxes. Depending on where you live and how you negotiate the acquisition, you could end up with as little as $19.1 million of a $50 million sale, due to taxes. But if you play your cards right, you can keep as much as $31.9 million from that same sale.

It all comes down to selling your assets vs. selling your stock.

When a corporate juggernaut like Google or Microsoft goes out to acquire a startup, they do their best to acquire the assets of the company rather than the stock that belongs to the shareholders. Like many business decisions, this is because of taxes. When a company buys assets, they can write off the purchase price over the next 15 years, and they know they’re not inheriting any undisclosed liabilities. When a company buys stock, they get no tax write-off and they acquire all liabilities, known and unknown.

Naturally the acquirer wants your assets rather than your stock, but selling your assets is going to take a big bite out of your side of the sale. Sell your assets and you’ll be taxed twice: once for the gain you make from the sale, and then again when you distribute the remaining amount to the stockholders.

You’d be better off selling your stock to the acquirer, because in that case you only have to deal with a single capital gains tax.  Of course, the tension here is that the acquirer will fight for an asset-based sale, as that’s what benefits them the most.

This is an argument worth having while negotiating with your acquirer. If you’re not yet convinced, just take a look at how wide the gap between how much you make from an asset sale and how much you make from a stock sale can be:

(Note: The chart below assumes a 2-year-old startup initially received $2.5M in seed funding, spent $2M developing their product in those first 2 years, and was then acquired for $50M at the end of the second year.  It’s also a C corporation, and we did different scenarios for California, Massachusetts, and New York/NYC to illustrate how state and city taxes can be a significant factor.)

Shareholder Net
Location Sale Amount Asset Sale Stock Sale
California $50M $19.6M $31.7M
Massachusetts $50M $21.9M $35.6M
New York/NYC $50M $19.1M $31.9M

Those numbers should put it into perspective – you must do all you can to get the acquirer to buy your stock rather than your assets. It helps to manufacture some incentive for the acquirer that plays to your advantage. You may be able to convince your buyer to go the stock route if you reduce the sale price of buying your company through stock, but leave the cost of buying your company through assets at full price.

The main takeaway here is sellers, beware. Don’t let your guard down just because someone’s throwing enough money to lay down in at you. Understand the tax implications of your decisions and favor selling your stock over selling your assets, or you might make a $10 million mistake.

 

$1.7M Mistake for FILING an 83(b)

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This is a very rare case when FILING an 83(b) Election made a bad situation worse:

Got a call last week from the CEO of a small, publicly-held company.  He had an easy-to-answer 83(b) Election question.  He was not a client, so we discussed other 83(b) Election issues to ensure it was done properly.

Some background:  the company hired a top executive and, as part of the compensation package, granted him 4M shares of Restricted Stock that vested over 48 months.  The grant was made a few months ago when the stock was trading at $0.85 per share.  The employee paid $400 for the shares, which was the par value ($0.0001 multiplied by 4M shares).  The employee filed the 83(b) Election timely and correctly.

Now the shocker – this employee now has $3.399M in taxable income and will owe about $1.7M in Federal and State (CA) income tax when he files his 2015 Income Tax return.  This is a result of the “bargain” purchase price ($400) he paid for $3.4M in stock (4M shares at $0.85 per share).  This “bargain” amount becomes taxable income, per IRS regulations.

To worsen matters, an 83(b) Election was filed.  Remember, that by filing an 83(b) Election, you are telling the IRS that you will pay them now, rather than later.  So, the IRS is expecting $3.399 in taxable income for this employee when he files his 2015 Income Tax return.

There is a procedure to rescind an 83(b) Election Form.  Though, if it is not done within 30 days of the grant, though, it is almost impossible to get it approved, as it needs the approval of the Commissioner of the IRS and “reasonable cause” is very, very narrowly defined.

It would have been much more advantageous not to file the 83(b) Election, thus choosing the “pay me later” option. Thus, when the stock vested, income tax would be owed on the value of the stock vested.  The employee, though, would have the opportunity to sell part of the stock (the Company is publicly traded) to pay the taxes.

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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.

 

Do It Yourself Guide to Prepare Your Startup’s Taxes

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OK,  you have a startup (let’s assume a DE C Corp) and are low on funds.  You would like Accountalent to prepare your taxes for you, but cannot afford the $150 per month, yet.  Here is a guide to do your taxes yourself and not get in trouble.  We will even review these filings for you at no cost.

First, what taxes are due?  Here is a list sorted by due date:

Form 1099s                        –               due January 31st

DE Franchise Return       –               due March 1

Income Tax return           –                due March 15th

Form 1099s:

Form 1099s are required for independent contractors or LLCs (none are required for corporations) to whom or which you have paid $600 or more in the calendar year.  They are also required for rent payments and law firms (even if they are corporations).  A Form 1099 is also required for the interest (not principal) amount of any notes converted to equity during the year.

  • Go to Track1099  and register for an account
  • Track1099 has two modules – Track1099 and TrackW9
  • Go to TrackW9 and enter your Company information and then enter the name and email address for anyone needing   a    Form 1099.  They will send a request to enter their W9 information (name, address, SSN, etc.)
  • When they have completed this process, you can then transfer the TrackW9 information to Track1099
  • In Track1099, you enter the amount paid each recipient
  • The following are the box numbers to use:
  • Box 7 – Independent contractors and lawyers
  • Box 1 – Rent
  • Form 1099-INT – interest
  • The recipient will then get an email from Track1099 to securely download their Form 1099
  • The cost is about $2 per 1099 form

 

DE Franchise Return:

The DE Franchise return is required for all DE C Corporations.  The amount of tax is a function of the Total Gross Assets, shares outstanding, and shares authorized.  The return can be filed only online at https://icis.corp.delaware.gov/Ecorp/logintax.aspx?FilingType=FranchiseTax and the tax is calculated when you enter this information. The names of the Board of Directors and an Officer are also required.  The tax for most startups is about $400 per year.

Income Tax Return:

Before you file your Income Tax return, you will need an accurate set of financial statements (Income Statement and Balance Sheet).  There are many software programs to file your business taxes, though we recommend TurboTax.  It costs about $150 per year for the software and includes the federal return, one state return, and e-filing both returns.  If you have more than one state, you may need a professional, as multi-state taxation can get complex.  You can download (PC version only) from Amazon.

TurboTax will bring you through an interview that facilitates the filing process.  One of the most important elections that you will make on the first-year return is the method of accounting.  You can choose either Cash Accounting or Accrual Accounting.  Give this decision some thought, as it can make a big difference in the amount of taxes paid.

How Accountalent Can Help You:

You need not be a paying client to enlist our help in this process. We are here to assist you and much prefer you utilize your funds to grow your business rather than use them to pay government fines and penalties.

So, before you file any forms, save to pdf and shoot our founder, Joe Faris an email at [email protected].  We will set up a ShareFile folder where you can upload and house these filings in a secure manner.  We will review and get back to you with any necessary changes.  Please do not “attach these filings to an email message, as these filings may contain sensitive, personal information.

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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.

 

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