Reduce AMT Tax – File an 83(b) to Reduce Taxes on Stock Options and Restricted Stock Units (RSUs)
Venture backed startup companies are big fans of using stock options as a major compensation tool to attract and retain employees. Companies often allow early-exercising of unvested stock options because the tax savings are a significant benefit and the invested capital is a demonstration of commitment by the employee. If your company’s stock value rises over the years, you can avoid two major tax issues by having exercised early. First is the ever-increasing AMT liability if the Fair Market Value of your stock rises before you finally exercise. Second is qualifying for long term capital gains based on the exercise date when you actually invested as opposed to the subsequent vesting date. To solve the latter problem, you need to file an 83(b) election within 30 days of your exercise date or else taxes will be computed when the possibility of forfeiture goes away (your vesting date) and the FMV is usually higher at the future vesting dates. A higher FMV results in higher taxes even though you exercised at an earlier date.
Filing an 83(b) with the IRS means that you are bound to consummate your intended stock purchase. The IRS isn’t capable of tracking whether you actually leave the company early resulting in a repurchase of the unvested stock, so they simply subject you to the applicable taxation up front based on your expressed intent. However, your cost basis and the fair market value are equal up front so there shouldn’t be any taxes due. The exception is if you waited some period of time before executing the early exercise and the fair market value of your company’s stock at the time of exercise had risen above your option grant exercise price. Even then, you may or may not be subject to tax depending on several factors such as whether these were qualified ISOs, the implied gain in value, and your level of income. Establishing the purchase date right away also makes the stock eligible for long term capital gains (LTCG) treatment after it is held for at least one year and at least 2 years has passed since the date of the option grant. There is a 20% federal tax savings associated with LTCG but drops to 15% if you are in the highest tax bracket. Although there are no additional tax savings for California because capital gains and ordinary income are taxed at the same rate, there are many other states that do provide an additional tax savings for LTCG. This savings was still applicable in 2015 but is subject to removal or reduction during each election cycle so please see a tax professional for the latest rules.
There is no special form for filing an 83(b) but a sample is provided here. You are cautioned to review this with your tax advisor for compliance with your particular situation since IRS rules are continually subject to change. Send 2 copies to the IRS along with a self-addressed stamped envelope for them to return a stamped acknowledgment. Keep a copy for your records at least until you received the stamped acknowledgment from the IRS. You no longer have to file a copy with your return to encourage e-filing but the applicability to you is an important thing to verify with your tax advisor.
It is a common misunderstanding that 83(b) elections don’t apply to RSUs because there is no exercise investment involved. RSUs have value but the taxability is deferred until the vesting is completed. For most startups, that occurs after the time vesting has finished and liquidity is available. As a result of this zero risk attribute, RSUs get taxed at the high ordinary income rate when vested. However, if you elect to pay taxes on the value of your RSU grant earlier, then you start the clock on long term capital gains eligibility. It is common for founders and early employees to get stock grants that are subject to repurchase by the company if they don’t stay around long enough to vest. For these people, it is usually favorable to make an 83(b) election and pay the relatively small amount of taxes that would be due while the stock still has a low FMV. For example, a founder could get a grant of 1 million shares at a PAR Value of $0.001 per share which means they will elect to recognize $1,000 of ordinary income associated with the grant during the initial tax year. The savings from long term capital gains can be extraordinary down the road when these same shares are sold for a high value which means the ROI on those initial taxes can be very high. If the founder’s stock grant isn’t subject to re-purchase then the 83(b) isn’t necessary but it is common for venture capital investors to request a vesting period as a condition of investment.
Exercising stock options early or paying taxes on a large RSU grant can require a lot of capital and yet the time to liquidity for your company can be quite long. As your shares are vested, you may be tempted to sell some shares to recover your original investment or perhaps fund other financial needs. Be aware that a sale is a taxable event and most likely at high tax rates. A sale also truncates any possibility of future upside on the shares being sold. An alternative solution is to get an advance from the ESO Fund. A key benefit of an ESO transaction is no repayment is due until a liquidity event is reached on the stock. Furthermore, if the stock becomes worthless, ESO absorbs the loss, not you. For more information, please contact us at the Employee Stock Option Fund.
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Get The Most Out Of Employee Stock Options.
An employee stock option plan can be a lucrative investment instrument if properly managed. For this reason, these plans have long served as a successful tool to attract top executives. In recent years, they've become a popular means to lure non-executive employees.
Unfortunately, some still fail to take full advantage of the money generated by their employee stock. Understanding the nature of stock options, taxation and the impact on personal income is key to maximizing such a potentially lucrative perk.
What's an Employee Stock Option?
An employee stock option is a contract issued by an employer to an employee to buy a set amount of shares of company stock at a fixed price for a limited period of time. There are two broad classifications of stock options issued: non-qualified stock options (NSO) and incentive stock options (ISO).
Non-qualified stock options differ from incentive stock options in two ways . First, NSOs are offered to non-executive employees and outside directors or consultants. By contrast, ISOs are strictly reserved for employees (more specifically, executives) of the company. Secondly, nonqualified options do not receive special federal tax treatment, while incentive stock options are given favorable tax treatment because they meet specific statutory rules described by the Internal Revenue Code (more on this favorable tax treatment is provided below).
NSO and ISO plans share a common trait: they can feel complex. Transactions within these plans must follow specific terms set forth by the employer agreement and the Internal Revenue Code.
Grant Date, Expiration, Vesting and Exercise.
To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date. They must comply with a specific schedule known as the vesting schedule when exercising their options. The vesting schedule begins on the day the options are granted and lists the dates that an employee is able to exercise a specific number of shares.
For example, an employer may grant 1,000 shares on the grant date, but a year from that date, 200 shares will vest, which means the employee is given the right to exercise 200 of the 1,000 shares initially granted. The year after, another 200 shares are vested, and so on. The vesting schedule is followed by an expiration date. On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement.
An employee stock option is granted at a specific price, known as the exercise price. It is the price per share that an employee must pay to exercise his or her options. The exercise price is important because it is used to determine the gain, also called the bargain element, and the tax payable on the contract. The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised.
Taxing Employee Stock Options.
The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. The taxation of stock option contracts depends on the type of option owned.
For non-qualified stock options (NSO):
The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. For example, if an employee is granted 100 shares of Stock A at an exercise price of $25, the market value of the stock at the time of exercise is $50. The bargain element on the contract is ($50 to $25) x 100 = $2,500. Note that we are assuming that these shares are 100 percent vested. The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately (or less than a year from exercise), the transaction will be reported as a short-term capital gain (or loss) and will be subject to tax at ordinary income tax rates. If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain (or loss) and the tax will be reduced.
Incentive stock options (ISO) receive special tax treatment:
The grant is not a taxable transaction. No taxable events are reported at exercise. However, the bargain element of an incentive stock option may trigger alternative minimum tax (AMT). The first taxable event occurs at the sale. If the shares are sold immediately after they are exercised, the bargain element is treated as ordinary income. The gain on the contract will be treated as a long-term capital gain if the following rule is honored: the stocks have to be held for 12 months after exercise and should not be sold until two years after the grant date. For example, suppose that Stock A is granted on January 1, 2007 (100% vested). The executive exercises the options on June 1, 2008. Should he or she wish to report the gain on the contract as a long-term capital gain, the stock cannot be sold before June 1, 2009.
Other Considerations.
Although the timing of a stock option strategy is important, there are other considerations to be made. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation. For any investment plan to be successful, the assets have to be properly diversified.
An employee should be wary of concentrated positions on any company's stock. Most financial advisors suggest that company stock should represent 20 percent (at most) of the overall investment plan. While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify. Consult a financial and/or tax specialist to determine the best execution plan for your portfolio.
Bottom Line.
Conceptually, options are an attractive payment method. What better way to encourage employees to participate in the growth of a company than by offering them to share in the profits? In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options.
As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax. Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands.

Reduce taxes on stock options

Techniques To Defer Or Reduce Taxes On The Sale Of Your Company's Shares (Part 1): QSB Stock.
Editor's Note: The Protecting Americans from Tax Hikes (PATH) Act of 2015 made permanent the special tax treatment for QSB stock acquired after September 27, 2010. The special treatment is now available for any QSB stock acquired after that date. For details, see commentaries from the law firms McCarter & English and Cooley.
Finding legal techniques to minimize taxes is almost as popular in the USA as stock compensation. Tax advisors can evaluate sophisticated techniques for reducing, or at least deferring, the tax dog's bite.
Your situation may be like the following. You've exercised your stock options and are holding on to the stock. Alternatively, you may have bought the stock from the company as an employee or a founder before it went public. Your company's stock performance has made you wealthy on paper, but because of a large concentration in company stock, you may find that you are no longer sufficiently diversified.
Like many individuals who experience volatility in the stock market, you closely monitor your portfolio. You are considering making changes to your investments but are concerned about taxes.
Quick Tax Review.
Most securities held over one year qualify for the preferential rate on capital gains. While this rate is lower than the rate on ordinary income, the tax can still be substantial. This potential tax has caused some investors to hold securities they might otherwise have sold. When evaluating your investment position, consider whether you can take advantage of the following little-known tax provision to help defer or reduce your taxes.
Qualified Small Business Stock.
After AOL bought out Netscape, Marc Andreessen, a founder of Netscape and now a venture capitalist, sold $5.7 million of AOL stock to finance his stake in his next company, and "he didn't pay a penny in capital gains taxes," according to Forbes magazine. If you have qualified small business (QSB) stock, you may be able to follow his example.
Detailed rules govern whether your stock is QSB stock. Generally, your stock may qualify if:
you bought or received your shares directly from a C-corporation (e. g. through the exercise of an option or the company's initial capitalization)
the corporation issued the stock after August 11, 1993, and had gross assets of $50 million or less prior to and immediately after issuance of the stock.
the corporation meets an "active business" test and is not involved in certain types of business, such as banking, farming, hotels, and professional services (e. g. engineering or consulting) Editor's Note: In TC Memo 2010-15 (Feb. 2010), the US Tax Court provides an example of how strictly the QSB stock requirements are interpreted. If you hold employee stock options in a small business and they are converted into options and then stock in a larger acquiring public company, you may not be allowed to use the benefits of this provision.
How You Defer Paying Tax On Sale Of QSB Stock: Roll Over Gains.
Section 1045 of the Internal Revenue Code (IRC) allows you to sell your QSB stock and defer paying any tax on the gain if you reinvest the proceeds into new QSB stock within 60 days from the date of sale. To qualify, you must meet a number of conditions.
Two of the significant requirements are:
You must have held your original QSB stock for more than six months (not one year, as with long-term capital gains).
You must elect to apply the rollover provisions of Section 1045. You make the election on your income tax return for the tax year in which the original QSB stock is sold. (See Rev. Proc. 98-48.)
Any sale proceeds you keep are taxed at regular rates. The deferral is available only to the extent that you would have had capital gain on the sale. So if the sale involves a disqualifying disposition of ISO stock, only the post-exercise appreciation can be deferred; any ordinary income is still recognized.
One of the nice things about this provision is that no limits exist on how much you can roll over or how many times you can elect rollover treatment. Another benefit is that the replacement stock doesn't have to be stock of only one company: you can roll over the proceeds into a diversified portfolio of QSBs and still defer the gain.
You should keep in mind, however, that while the tax has been deferred, it has not been eliminated. The basis of your old shares is "carried over" into your new shares. Unless you hold the new shares until death or give the property to charity, a tax will be due should you sell your QSB shares and not qualify for further rollover. Even so, the tax law may provide an additional benefit when you sell QSB shares.
Complications And The 0% Rate: You Sell QSB Shares Without Another Rollover.
The next two situations make QSB stock more complex, and in these cases it is definitely time to call in an accountant, financial planner, or tax lawyer familiar with this provision. I'll run through the basics so that when you meet your advisor (or try to impress your friends!) you understand how these situations work.
Congress, in an effort to spur investment in small businesses, enacted Section 1202 of the IRC, which provided a 50% gain exclusion under the 1993 tax rates (the capital gains rate was 28% in 1993). For taxpayers in the 25% tax bracket or above, the enactment of Section 1202 reduced the tax rate on sales of certain QSB stock to 14%, which seemed a good deal when the long-term capital gains rates were 28% in 1993.
The Small Business Jobs & Credit Act of 2010 provided that for qualified small business stock issued between September 27, 2010, and the end of 2010, the exclusion was 100% (i. e. 0% tax on the capital gains). Afterwards, Congress extended the expiration date of this provision through several tax laws and, for the duration of the extensions, it excluded capital gains from being added to the alternative minimum tax (AMT) income calculation. The Protecting Americans from Tax Hikes (PATH) Act of 2015 made permanent the special tax treatment for qualified small business stock. Therefore, the special treatment is now available for any QSB stock acquired after September 27, 2010. For the potential impact of making this exclusion provision permanent, see an article in Accounting Today .
Qualifying for the rate, however, is a bit more complicated than qualifying for rollover treatment of gains. Some of the requirements that must be met include:
You must have held the QSB stock for more than five years. If your basis in the QSB stock was determined as a result of a Section 1045 rollover, the holding period for purposes of Section 1202 includes the time during which those previous QSB shares were held.
Limitation on gain exclusion. For any one taxpayer, the maximum amount of eligible gain with respect to the stock of a single issuer that may be subject to the exclusion is the greater of either $10 million or 10 times the taxpayer's basis in the stock of the issuing corporation.
Effect of the alternative minimum tax (AMT). Even though this all may have started with nonqualified stock options or founder's stock, AMT can creep into it for QSB stock acquired prior to September 27, 2010. A portion of the gain excluded from gross income is added back to taxable income for the purpose of computing alternative minimum taxable income. To the extent you are subject to the AMT, the net effect will be to eliminate the reduced tax benefit.
An article in Investment News reports that, in a move sometimes called "stacking," owners of QSB stock can try to maximize the $10 million exclusion amount by gifting shares to separate non-grantor irrevocable trusts for the benefit of children or other family members. Each trust would then have its own $10 million gain exclusion. The authors point out that uncertainty lingers around this planning idea. They recommend consulting with tax advisors to obtain their opinions on the strategy.
You Sell Your QSB Shares At A Loss.
No one wants to sell shares at a loss, and until recently no one thought they might have to, but even in this instance the tax law may offer a special benefit if you sell QSB shares at a loss. For most types of capital assets held over one year, any loss recognized on sale is considered to be a long-term capital loss, which is deductible only against capital gain (except for up to $3,000, which can be used to offset ordinary income).
Ordinary losses, by contrast, are deductible in full against ordinary income. Since ordinary income is often subject to a much higher tax rate (up to 35%) than capital gains, ordinary losses usually generate much greater tax savings.
If your QSB shares satisfy the requirements of IRC Section 1244 as "small business stock," up to $100,000 each year on a joint return of what would otherwise be capital loss may be treated as an ordinary loss. If, after applying the limitation, the ordinary loss exceeds your net income for the year, the excess is even available to offset income from prior and future years. The loss on the stock can be caused by a sale or the company's liquidation, or if the shares become worthless.
Editor's Note: You also need to analyze the state-tax impact of QSB stock. California, for example, has adopted its own variations of the rollover and gain-exclusion provisions. According to The M&A Tax Report , a Californian tax official told the editor that " every California return with QSBS on it gets audited." The publication's June 2007 issue adds:
"If replacement stock is purchased within 60 days of the sale of the QSBS, but the taxpayer fails to label the replacement stock on the taxpayer's income tax return, California auditors will generally disallow rollover treatment and refuse to permit the taxpayer to file an amended return correcting the election."
The only exception, the publication adds, occurs if an incorrect sale date is referenced.
In October 2007 the IRS issued final regulations (TD 9353 in IRB 2007-40) that provide guidance on applying QSBS rules to partnerships (and their partners) that hold the stock.
Part 2 looks at another way to defer tax by investing your gains in specialized small business investment companies (SSBICs).
The author is a former partner of a major accounting firm, where he was the National Director of Personal Income Tax and Retirement Planning. This article was published solely for its content and quality. Neither the author nor his former firm compensated us in exchange for its publication.

16 Legal Secrets to Reducing Your Taxes.
Don't miss these tax deductions and credits, which can add up to significant savings over the years.
By Barbara Friedberg, Contributor | July 6, 2015, at 8:32 a. m.
Spend a few hours each year brushing up on tax law and studying the deductions and credits available. (iStockphoto)
Around the time I stopped fighting with my parents and began listening to them, my dad imparted some brilliant financial advice. He told me to become a scholar of the tax law. OK, perhaps he didn’t use those exact words, but the message was the same: Know the tax law and take every tax deduction to which you are entitled.
This advice stuck with me, and I’m certain it has saved me thousands of dollars.
The IRS website offers excellent resources to help you further understand the following tax deductions and credits. Study the credits well, as those benefits reduce your taxes dollar by dollar. In other words, if you owe $1,000 in taxes and receive a $150 tax credit, your taxes owed decrease to $850. That’s an extra $150 in your pocket.
By spending a few hours each year keeping abreast of the tax law, you can save thousands on taxes over the years. In fact, keeping a tax-reduction mindset in your everyday life will serve your finances well. Here are 16 tips to reduce what you pay in taxes:
1. Retirement account contributions are a top tax-reduction tool, as they serve two purposes. Most contributions (except the Roth individual retirement account) allow you to deduct from your taxable income the amount paid into the retirement account. This reduces your total taxable income. These funds also grow tax-free until retirement. If you start early, this strategy alone can secure your retirement.
2. Contribute to a health savings account if you have a high-deductible medical plan. The contributions unused for medical expenses can roll over indefinitely and grow tax-free (similar to the assets in a retirement account).
3. Combine a vacation with a business trip, and reduce vacation costs by deducting the percent of the unreimbursed expenses spent on business from the total costs. This could include airfare and part of your hotel bill (proportionate to time spent on business activities).
4. If you work for yourself or have a side business, don’t be afraid to take the home office deduction. This allows you to deduct the percent of your home that is used for your business (on Schedule C, 1040). If the guest bedroom is used exclusively as a home office, and it constitutes one-fifth of your apartment’s living space, you can deduct one-fifth of rent and utility fees for your home office.
5. Self-employed individuals (either full time or part time) are eligible for scores of tax deductions. A few of those expenses include business-related vehicle mileage, shipping, advertising, website fees, percent of home Internet charges used for business, professional publications, dues, memberships, business-related travel, office supplies and any expenses incurred to run your business.
6. Self-employed individuals who pay 100 percent of their Social Security taxes owed (15.3 percent) can deduct 50 percent of the taxes paid. You don’t even need to itemize to claim this tax deduction.
7. Unreimbursed vehicle expenses are another frequently overlooked tax break. You can’t deduct commuting costs, but if you travel to satellite offices or drive your own vehicle for business and aren’t reimbursed, you can deduct mileage costs.
8. Tax credits are gold. They are deducted from the tax owed. The American Opportunity Tax Credit is available for all for years of college. You receive a tax credit on 100 percent of the first $2,000 spent on qualifying college expenses and 25 percent of the next $2,000 for a maximum of $2,500 per student. That’s $2,500 deducted from the amount of tax owed (as long as you meet certain income requirements regarding school courses that improve job skills).
9. The Lifetime Learning Credit is great for adults boosting their education and training. This credit is worth a maximum of $2,000 per year (up to 20 percent of up to $10,000 spent on post-high school education) and helps pay for college and educational expenses that improve your job skills.
10. The Earned Income Tax Credit lowers the overall tax bill for low - and moderate-income working families.
11. The state sales tax break gives itemizers the chance to either deduct state income or state sales taxes paid. This benefit is great if you live in a state without income taxes.
12. Investors: When calculating the cost basis after selling a financial asset, make sure to add in all of the reinvested dividends. That increases the cost basis and reduces your capital gain when you sell the investment.
13. Charitable deductions made with payroll deduction (such as the United Way), checks, cash and donations of goods and clothing are all deductible. These deductions add up and are often overlooked. Don’t forget to include the cash you give to the Salvation Army and the $20 you place in the collection plate at church each week.
14. If you are an adult child who is not claimed as a dependent by your parents, here is a possible tax break for you. If your parents pay back your student loans, the IRS assumes the money was given to the child, who then repaid the debt. Thus the young adult child can deduct up to $2,500 of student loan interest paid by his or her parents.
15. I remember tallying job hunting costs to deduct from my meager tax bill in the past. If you’re looking for a job in the same field, you can deduct all related expenses as miscellaneous expenses if you itemize (they must pass a 2 percent threshold). You can deduct these expenses even if you didn’t find a new job.
16. Are you in the military reserves, such as the National Guard? If you travel more than 100 miles from home and need to be away overnight, you can deduct lodging and half of the cost of meals while you are away. Of course, you can also deduct mileage costs.
Do not count on a tax preparer to know every deduction for which you are eligible. Be a smart consumer and know the tax benefits you can claim. Every additional deduction you claim increases your disposable income.
This article was originally published on March 10, 2014. It has been updated.
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