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.
Even if you're still in the planning stages for your new enterprise, it's never too soon to start thinking about these six operational issues that will impact and contribute to the success of your business.