Maximizing Tax Benefits in an IPO for Equity Owners in the 2024 Panorama

The gratification an organization feels after issuing an Initial Public Offering (IPO) is immense and unmatchable. It is like that organization has achieved an extensive milestone and enjoys the bounty of flying on top of the sky. However, it is to be remembered that success always brings pitfalls with it, and it is quite necessary to deal with their downside appropriately; otherwise, the entire plan may collapse and you have to fold the entire portfolio.

Therefore, the owners need to understand how they can maximize their return on such an offering, particularly when it comes to taxes.

Power of 83(b) Election:

The 83(b) election has certain powers that need to be understood adequately for the investors so that none of the prospects could be missed out.

Early Exercise:

This is the time when you receive stock options or restricted stock units (RSUs) as a portion of your pre-IPO compensation package. They normally include a vesting period, and Section 83(b) of the election permits you to pay ordinary income tax on the fair market value (FMV) of the stock at the time of the grant instead of waiting for vests and possibly facing a higher FMV and tax rate.

Other Tax Strategies for Equity Owners – Beyond 83(b)

The 83(b) is a significant tool that facilitates owners attainment of tax benefits, but it’s not the only option for maximizing tax benefits on the issuance of an IPO. There are some additional strategies to look for:

Qualified Small Business Stock (QSBS):

The QSBS exemption or exclusion is not a part of equity compensation but rather gives and offers benefits to the equity owners, where employees and investors are subject to lower tax rates or get exemptions up to 100% of capital gains on the sale of the stock up to $10 million. 

However, there are clear-cut criteria for eligibility for QSBS, which include that the company must be US based and not have more than $50 million in business assets. In addition, QSBS can only apply to stock, and any holding options must be first exercised before converting into QSBS shares.

Staged Liquidity Events:

This strategy allows the investors to sell the shares in small tranches over several tax years. Eventually, as a result, it minimizes the tax burden and enables you to manage the risk efficiently.

Let’s look at this in detail with an example.

If you sell the stock all at once, you will definitively fall into the higher bracket for capital gains tax, whereas if you spread out the selling into small tranches, it might take you to a smaller bracket and ease out your tax burden, and by doing so, your cash flow stream could be maintained smoothly.

Furthermore, the tax rate may vary from time to time, so if, for instance, the sale of stock is done in tranches, it might allow you to benefit from the fluctuating tax rates and possibly lower rates.

Benefits of Making the 83(b) Election:

• Locking in a Lower Tax Rate:

By electing early, you can lock the tax rate potentially at the lower FMV on the grant date and save significant money in the long run in case the stock prices increase before the vesting period.

• Ignoring Income Tax on Appreciation:

The increase in stock value between the grant date and the exercise date is normally taxed as a capital gain, typically at lower rates than ordinary income.   

Conclusion:

Summing up, it is concluded that an IPO has multifarious benefits, and it gives you the power to use Section 83(b) in your favour, but it also includes various challenges and concepts that equity owners and employees should understand and be well equipped to cope with effectively.

In order to implement these concepts successfully, expert assistance is of dire significance, which is why tax experts like Dimovtax.com comes to the rescue. With a team of qualified CPA experts, Dimovtax provides the necessary information required to use Section 83(b) for your benefit.