Did not file for section 83b election within 30 days of c-corp startup conversion, what are the options now?

Asked almost 4 years ago - Fremont, CA

We are co-founders of a startup & we converted from an LLC to C-Corp in sept-2010. The company has restricted stock with vesting. Unfortunately we did not file 83b election within 30 days of c-corp conversion. Now we are receiving VC investment in our company and discovered the 83(b) omission.

Our lawyer is suggesting amending the stock restriction agreement to allow the pledge of restricted stock as collateral to a bank, the property (in this case, shares of restricted stock) would be considered transferrable for purposes of Section 83, and therefore taxable under Section 83(a). The provision permits the pledge of shares to a bank as collateral and would achieve the same tax result under Section 83 as filing a Section 83(b) election. Is this correct? Is there any risk with IRS?

Attorney answers (3)

  1. Bryant Keith Martin

    Contributor Level 18

    Answered . OK, now I see what he was thinking: If you have the power to transfer it to a bank as a pledge, it’s “transferrable”. Problem is it’s a two pronged test and you are still stuck by the other prong. Section83(c)(2) states that the rights are transferrable “only if the rights in such property of any transferee are not subject to a substantial risk of forfeiture.” (“SROF”) If you terminate your employment, I am sure your stock restriction Agmt (“SRA”) provides for forfeiture. So there is still a SROF.
    What did your attorney think about the Alternate Plan I suggested? Mr. Koenig is correct in stating that the pending deal increases the value of your shares. I asked whether, and assumed that, the deal has not been signed and is still contingent, so I thought you could be fairly aggressive in discounting the value of the bird in the bush, to minimize the current taxes payable. However, now you tell me only that the deal has not closed. Am I to assume that it has been signed? In that case there would be no window when no SROF exists, so you still could not make the 83(b) election, without a temporary concession from the VCs. Also, in that case the tax hit could be substantial. It may still be better than paying at ordinary income tax rates on your gain on the shares as the company goes public. You need to get some advice on the current value of your shares and then run the numbers to see whether paying the smaller tax now is worthwhile, vs. the possibility that the company may eventually become worthless.
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    (Bryant) Keith Martin
    sbbizlaw.com

  2. Bryant Keith Martin

    Contributor Level 18

    Answered . I am sure your lawyer has thought this through, but off the top of my head, I don’t see how his plan works. If you pledge the shares to a bank as security for a loan, and the deferred vesting provisions are canceled, what is to keep you from paying off the loan and receiving fully vested stock? There is no longer a substantial risk of forfeiture. The VC’s would not be happy without deferred vesting. Is it a huge loan? If payoff is contingent on your continued service, then the substantial risk of forfeiture exists at all times, and you have not triggered 83(a) taxation. I suppose I need to see the stock restriction Agmt.
    Alternate Plan: If you have not yet signed the deal with the VC’s, your corp can authorize immediate 100% vesting so Section 83(a) applies with some minimal amount of tax. Then as part of the VC deal, you accept new restrictions so it becomes restricted stock again, and you promptly file the 83(b) election to be taxed currently. This seems too easy, I must be missing something. I will think about it and get back to you if I get any more ideas.
    FEEDBACK: Both AVVO and other readers are interested in your feedback on the quality of the answers. Plz check the “thumbs up” symbol if you find an answer helpful or the “thumbs down” symbol if not.
    DISCLAIMER—This answer is for informational purposes only under the AVVO system, its terms and conditions. It is not intended as specific legal advice regarding your question. The answer could be different if all the facts were known. This answer does not establish an attorney client relationship. I am admitted only in California.
    (Bryant) Keith Martin
    sbbizlaw.com

  3. John L Koenig

    Contributor Level 9

    Answered . I agree with Bryant's proposal, but there could be an issue with current valuation of your shares if you are already down the road a ways with the VCs, such as having signed a term sheet, or more.

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