Understanding the IRS 83(b) Election for Delaware Business Owners
Many entrepreneurs spend months planning their business and only days forming it, but some of the most important decisions can arise after the company is already incorporated. When forming a Delaware corporation, many business owners focus on the incorporation process itself, including selecting a company name, appointing directors and officers, and obtaining the necessary organizational documents. However, after a company has been formed, founders may encounter certain tax-related considerations that arise as part of the company's post-incorporation planning. One such consideration is the IRS Section 83(b) Election.
What Is an IRS Section 83(b) Election?
An 83(b) Election is a filing made directly with the Internal Revenue Service (IRS). It is generally associated with stock or other ownership interests that are transferred to an individual but remain subject to certain restrictions. A common example is founder stock that vests over time rather than becoming fully owned immediately.
The purpose of the election is to allow an individual to recognize the value of the ownership interest for tax purposes at the time it is granted rather than when it later vests. In many startup companies, the ownership interest may have little or no value when the company is first formed. If the company grows and increases in value over time, the value of those ownership interests may increase as well. This potential increase in value is one reason why founders often discuss the 83(b) Election with their tax advisors. In general terms, if an ownership interest has a relatively low value when it is initially granted and later increases in value as the company grows, the election may affect how and when certain taxes are calculated. Because every situation is different, business owners often seek professional guidance to better understand the potential tax implications and whether the election is appropriate for their circumstances.
When an 83(b) Election May Apply
Although not every business owner will need to file an 83(b) Election, it is a federal tax matter that may arise after a company has been formed and ownership interests have been issued.
Many startup companies formed as Delaware corporations utilize vesting schedules for founder shares and other equity awards. As a result, discussions regarding the potential applicability of an 83(b) Election often occur shortly after the company has been organized and ownership interests have been issued.
Timing is one of the most important aspects of the 83(b) Election. The IRS generally requires the election to be filed within 30 days of the transfer of the ownership interest. Because the filing deadline is relatively short, founders who believe the election may apply to their circumstances often review the filing requirements soon after receiving their shares or other ownership interests.
How to File an 83(b) Election
It is important to understand that the 83(b) Election is separate from the process of forming a Delaware company. The Delaware Division of Corporations does not process, approve, or maintain records regarding 83(b) Elections. Similarly, when forming a Delaware corporation or LLC, clients are not required to disclose whether an 83(b) Election may be filed in the future.
The election is submitted directly to the IRS by the individual receiving the ownership interest and is generally considered a personal tax filing rather than a company formation filing. As such, it falls outside the scope of the incorporation process itself.
Not every company formation involves circumstances where an 83(b) Election is relevant. Whether the election applies depends on the nature of the ownership interests being issued and any restrictions or vesting conditions attached to those interests. As a result, the applicability of the election will vary from one company to another.
For Delaware business owners, understanding the basic purpose and timing of the 83(b) Election can be helpful when navigating the post-incorporation phase of building a company. While the election is a federal tax matter handled directly with the IRS, awareness of its existence and filing deadline can help founders better understand one of the many considerations that may arise after a business has been formed.
If you have questions about forming a Delaware corporation or Delaware LLC, contact Harvard Business Services, Inc. at 1-800-345-2677 or visit www.delawareinc.com.
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