Managing 83(b) elections for profits interests

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An 83(b) election is a provision under the Internal Revenue Code that gives recipients of restricted securities the option to pay taxes on the total fair market value (FMV) of the award at the time of issuance. This provision is used to allow employees to get the most favorable tax treatment when being issued securities.

One form of employee compensation that typically requires an 83(b) election is profits interests in an LLC or partnership. 

What are profits interests?

Profits interest units (PIUs) are a type of equity typically issued to employees in a partnership (LLC). They are a restricted share that gives the holder a right to a portion of the future value—typically of future profits or a sale—of the company under certain restrictions. PIUs are generally restricted by vesting, meaning certain time or performance criteria must be met before the recipient can start recognizing the value of the profits interest. When a profits interest is originally issued, the total FMV of the award is generally $0. 

PIUs are becoming a popular form of equity compensation because of their favorable tax status for recipients. LLCs often issue them to give managers and employees a share in the company. When an 83(b) election is made, the tax advantage of PIUs is similar to that of ISOs issued from a C-corp. 

Why is an 83(b) election required?

Most LLCs require 83(b) elections to preserve the favorable tax status of profits interests. As mentioned before, an 83(b) election gives recipients the ability to pay taxes on the total FMV of the award at the time of issuance. If PIUs are issued with an FMV of $0 (as they generally are), the recipient won’t pay taxes at the time this election is made.

It’s very important for PIU holders as well as companies to make sure this filing happens within 30 days of issuance, as required by the IRS, so that employees can take advantage of the tax favorable status. If an 83(b) election isn’t made, or isn’t made in a timely manner, the award could be taxed upon vesting—before the holder begins to realize any of the value of profits interest.

How do I manage 83(b) elections?

There are a few standard steps you need to take to complete the 83(b) election process:

1. Encourage recipients to download, populate, and sign an 83(b) form once they receive their profits interest. 

If you are using Carta, our platform automatically notifies the recipient when they have a pending 83(b) election:

83(b) elections for profits interests

The recipient can then download our pre-populated form and follow the directions to populate it:

83(b) elections for profits interests instructions

2. Collect the executed forms so you have a record of the election on your company’s end.

Carta stores the populated form directly on the profits interest. Any company administrator can retrieve the form from Carta:

83(b) elections for profits interests

3. Store the 83(b) elections for reporting purposes.

Carta stores each 83(b) election directly on the relevant PIU. You can then filter and report on PIUs based on the 83(b) status:

83(b) elections for profits interests

PIUs are becoming an increasingly popular form of equity compensation from LLCs due to the tax favorable status for employees. However, this favorable tax status can only be guaranteed if an 83(b) election is submitted within 30 days of issuance. Learn more about how Carta can not only help your LLC generate, store, and report on 83(b) elections, but also manage your cap table, organize your corporate governance documents, and more.

 

DISCLOSURE: This publication contains general information only and eShares, Inc. dba Carta, Inc. (“Carta”) is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services.  This publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that may affect your business or interests.  Before making any decision or taking any action that may affect your business or interests, you should consult a qualified professional advisor.  This communication is not intended as a recommendation, offer or solicitation for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein. 

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