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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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.