83(b) Elections – What You Need to Know

Posted September 18th, 2012 in Compensation and benefits, Founders, Startups by Claire

As an employee, founder or an investor in a startup, you may receive restricted stock that will vest at a later date. Upon receipt, you have the option of making an 83(b) election with the IRS. But what is an 83(b) election? Why should you consider making one, and what’s the process for doing so? The following paragraphs contain information about the basics of an 83(b) election and why it may be beneficial to file one.

What is it:

An 83(b) election is a optional provision that directs the IRS to tax the stock at the time of the grant, when it may be worth very little or when payment is made. The relatively low worth of the stock at the time of the grant (versus at the time that it vests) helps the grantee minimize his or her potential tax liability when he or she opts for an 83(b) election.

Why should you do it:

For a startup, the stock is likely to be worth much less at the time it’s granted than at the time it vests. Ideally, making an 83(b) election will result in paying less taxes because you’ll be taxed on the stock at the time of the grant instead of when it vests, when it hopefully holds a higher value.

When you should do it:

An individual must file the letter of election with the IRS either prior to the date of the stock purchase or within 30 days after the purchase date. There is no exception to the 30-day rule.
The following circumstances would be advantageous for an 83(b) election:
• If the amount of income reported at grant is small;
• If the stock has moderate to high growth prospects; and
• If the risk of stock forfeiture is very low.
However, under these circumstances apply, you might reconsider making an 83(b) election:
• If there is a moderate to high risk of stock forfeiture; or
• If there’s a heavy tax burden at the time of the grant in addition to low to moderate growth prospects.

How you should do it:

Within 30 days of the purchase date, you must send a letter to the IRS stating your intent to make the election. You must include the following items in the letter:
- Your name, address, and taxpayer identification number.
- A description of each property for which you are making the choice.
- The date or dates on which the property was transferred and the tax year for which you are making the choice.
- The nature of any restrictions on the property.
- The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property for which you are making the choice.
- Any amount that you paid for the property.
- A statement that you have provided copies to the appropriate persons.

You must send your letter to the IRS where you file your tax returns; you can find the address for the office you need on the IRS website. You should also make copies of your 83(b) election documents because in addition to filing with the IRS within 30 days of the grant, you also have to file it with your personal income tax return. Finally, send a copy of the election to the company that granted you the stock for them to keep in their records.

California: New employment laws will affect startups and small businesses

Posted January 25th, 2012 in Compensation and benefits, Employment, Small businesses, Startups by Claire

New employment laws that went into effect on January 1 will impact California startups and small businesses. One of the new laws that businesses won’t want to ignore is SB 459, which imposes heavy penalties of between $5,000 and $25,000 for the “willful misclassification” of employees as independent contractors. The law is designed to crack down on the common employer practice of classifying employees as independent contractors (which have much fewer tax and legal requirements), and reflects the trend towards increased scrutiny of worker classification.

Other laws that went into effect expand health benefits for women on pregnancy disability leave, prohibit some employers from doing credit checks on certain workers or job applicants, and increase disclosure requirements for employers hiring non-exempt workers.

How to split your startup’s equity

Posted September 29th, 2011 in Compensation and benefits, Startups by Claire

When it comes to splitting the company, equal is not always equitable.

Do you and your co-founder have a 50-50 (or 33-33-33) equity split?  If so, it’s probably for two reasons: one, it’s simpler, and two, you may believe, as most people do, that equal splits are generally the fairest.  However, equal equity splits are not always the best thing for a company
because they often favor one founder, which can lead to disputes later.  The rule of thumb is, the equity split should as closely as possible approximate each founder’s relative contributions, both
past and anticipated, to the venture.  This includes cash contributions, time contributions, other
contributions including IP, business contacts and physical assets, and each individual’s opportunity costs in pursuing the venture.

If you haven’t already, sit down now with your co-founder and discuss each of your past and future contributions and try to come to an agreement about a fair equity breakdown.

Equity battles are one of the most common reasons for startups to fail, and for that reason, investors will scrutinize the equity split of a company they are considering.  So even though it may be tough to work out a breakdown that represents each individual’s contribution, it’s an important investment in the future stability and success of your company.

Are Incentive Stock Options really all that?

Posted September 26th, 2011 in Compensation and benefits, Startups by Claire

Everyone who works at a startup wants their stock options, and they want the good kind – incentive stock options (ISOs).  Why?  ISOs offer two distinct tax advantages over their less popular sibling, nonstatutory stock options (NSOs).  First, the taxable event for an ISO is later than for an NSO.  NSO holders have to pay income tax when they exercise, but ISO holders do not have to pay until they sell the underlying stock, as long as they meet the holding period requirements (see below).  Second, the tax rate that ISO holders pay is lower.  NSO holders have to pay ordinary income tax on the difference between the strike price and the fair market value upon exercise, whereas ISO holders are subject to the lower capital gains rate on the difference between the purchase price and the sale price.

ISOs have a number of requirements.  Only employees may get ISOs.  Also, ISO holders have to hold on to their shares for the required holding period (1 year from exercise, 2 years from option grant date).  In most cases, ISOs have to be exercised less than three months after the termination of employment.  Also, the exercise price must be at or above the fair market value of the stock on the grant date.  If any of the ISO requirements are not met, ISOs will be treated as NSOs.

ISO holders should note that they may still be subject to the alternative minimum tax (AMT) in the year that they exercise their options, and depending on the individual tax situation the AMT may significantly reduce the tax benefits of ISOs.  If you have ISOs that you are thinking of exercising, you should consult your tax advisor on the potential AMT consequences.

Generally, however, ISOs are still an attractive form of equity for most.  Just make sure that you’re aware of their requirements and implications.

 

RSUs decoded

Posted September 14th, 2011 in Compensation and benefits by Claire

Have you been offered RSUs or heard talk about them, and are wondering how they work?  If so, read on.

RSU stands for Restricted Stock Unit, and RSUs are basically a promise by an employer to grant a set number of shares of the company to the employee according to a vesting or forfeiture schedule.  Once the vesting and forfeiture requirements have been met, the shares are delivered to the employee.   Here’s an example: say you are granted 100 RSUs subject to a four-year vesting schedule, with 25% of the RSUs vesting each year.  If you stay with the company for a year and meet all requirements set forth in your RSU agreement, you will get 25 shares of the company at the end of the first year.  If you stay a second year, you’ll get another 25 shares at the end of the second year, and so on.

RSUs are becoming increasingly popular as a form of equity compensation tool.  Employees tend to like them because unlike stock options, where you still have to buy the shares once the option vests, with RSUs employees are granted actual shares of the company as soon as the RSUs vest.  One thing RSU recipients should know is that each time RSUs vest and the recipient is granted shares, the recipient will generally recognize ordinary income on the market value of the shares.

Like stock options, RSUs don’t confer any voting or other shareholder rights upon the holder, because they do not represent actual shares of the company.  However, once RSUs vest and shares are issued, the RSU holder becomes a stockholder with regular stockholder rights.

In short, if you’ve been offered RSUs, be glad, especially if your company is doing well – they can be a very valuable benefit.  Just don’t forget that you’ll owe taxes when the RSUs vest.