What are the consequences of underestimating the fair market value of a pure startup in an 83(b) election?
Our company has just received its first round of funding which included issuance of restricted stock to the founders. Founders will elect 83(b) but want it to be a low as possible on the stock valuation to minimize current income tax. If the valuation used is later determined to be too low, does it risk invalidating the 83(b) election?
The valuation of a business is never straightforward--particularly not with pure startups where there's no historical way (e.g., earnings or other ratios) to gauge the fair market value. What's particularly concerning are the tax consequences. The greater the discrepancy in value between the compensation income when the founders receive the shares and the value when the stock is sold will increase the long-term capital gain liability. However, by volunteering to pay tax on the value of the stock in the year it is received, the founders may be able to reduce their overall tax liability. Speak to a good accountant who understands 83(b) elections, business valuations, and the ramifications of the choices.
Nina L. Kaufman, Esq. is an award-winning New York City attorney, edutainer and author. Under her Ask The Business Lawyer brand, she reaches thousands of entrepreneurs and small business owners with her legal services, professional speaking, information products, and LexAppeal weekly ezine. She also writes the Making It Legal blog.