Growth shares and the 83(b) election for US founders

Why growth shares raise an 83(b) question for a US founder

Growth shares are a class that shares only in value created above a hurdle set at issue, so their market value on day one is usually low. When they are issued to a founder or employee in connection with their work and can be forfeited, US tax waits until the forfeiture risk lapses, by which time the value may be much higher.

Section 83 of the Internal Revenue Code taxes property received for services when it becomes substantially vested. Publication 525 (opens the official IRS page in a new tab) explains that this means the shares are transferable or no longer subject to a substantial risk of forfeiture, and the income is their value at that point less anything paid. A vesting schedule, or a requirement to sell the shares back at cost on leaving before a set date, is the usual form of that risk. Under the regulations, a clawback that applies only on dismissal for cause or for a crime does not count.

The consequence for a growing company is that each tranche becomes US compensation income as it vests, measured at the value of the shares on that date. The founder pays ordinary income tax on growth that has not been sold and may never be. The 83(b) election exists to change that result, and growth shares are where it is most often relevant.

What a section 83(b) election does for shares in a UK company

The election tells the IRS to tax the shares in the year they are transferred, on their value at transfer less the price paid. The later vesting is then ignored for income tax purposes, and growth after the election is generally capital gain when the shares are sold. It works the same way for shares in a UK company as for a US one.

The basis of the shares for computing the eventual gain is the amount paid plus the amount included in income. Where a founder pays full market value for growth shares, the income figure on the election is nil, but the election still fixes the timing. The trade-off is the risk of forfeiture. If the shares are later lost, for example because the founder leaves before vesting, the loss allowed is limited to what was paid less anything recovered, and the tax paid on the election is not refunded.

The election is a one-way door. Publication 525 states that it cannot be revoked without IRS consent, and that consent is given only where there was a mistake of fact about the underlying transaction. It cannot be made for a stock option, which is why our posts on EMI options and CSOP options treat it as relevant only to shares acquired on exercise that are still restricted. The statement itself must include the following.

• Name, address and US taxpayer identification number of the person making it
• A description of the shares, including class and number
• The date of transfer and the tax year for which the election is made
• The nature of the restrictions, such as the vesting or leaver terms
• Fair market value at transfer, ignoring restrictions that will lapse, and the price paid
• A statement that copies have been given to the appropriate people

How to file an 83(b) election from the UK

File either Form 15620 (opens the official IRS page in a new tab) or a signed written statement with the IRS office where you file your return, no later than thirty days after the shares are transferred. A founder living in the UK uses the address that the Form 1040 instructions list for filers in a foreign country, and gives a copy to the company.

The form's instructions describe sending it by post, and they say that where the thirtieth day falls on a Saturday, Sunday or legal holiday, an election postmarked on the next working day is treated as timely. Posting from the UK adds risk, because the date that matters is the postmark. Use a tracked international service and keep the receipt. File only one election for the same shares, so the IRS does not receive two competing versions.

A copy must go to the company the services are performed for, and to anyone else who receives the shares if that is not the founder, such as a family trust. Under the current regulations there is no longer a requirement to attach a copy to the Form 1040 for the year of transfer, but the income, if any, is reported on that return. Our individual tax returns service keeps the election and proof of posting with the return file.

How the UK section 431 election differs from 83(b)

The UK election is a joint agreement between the employer and the employee under section 431 of the Income Tax (Earnings and Pensions) Act 2003. HMRC's manual on elections to exclude restrictions (opens the official HMRC page in a new tab) says it must be made within fourteen days of acquisition. It taxes the shares at acquisition on their unrestricted market value.

Without a UK election, shares that can be forfeited for no more than five years are generally not charged to income tax on acquisition. The charge comes instead when the restriction lifts, or when the shares are sold while still restricted, on a proportion of their value at that time. A section 431 election switches off that regime, so growth after acquisition falls into capital gains tax. The election is irrevocable, and there is no requirement to lodge it with HMRC, so the signed copy is the evidence and both parties should keep it.

The two elections answer the same question in different systems, and a founder usually wants both or neither. HMRC's guidance on employee share schemes (opens the official GOV.UK page in a new tab) and the IRS guidance do not refer to each other. The main differences are these.

• 83(b) is made by the individual alone; section 431 needs the company's signature as well
• 83(b) must be filed with the IRS; section 431 is kept by the parties
• 83(b) allows thirty days from transfer; section 431 allows fourteen days from acquisition
• Both measure value as if lapsing restrictions did not exist, but the valuations are separate exercises
• A UK election made without an 83(b) election leaves the US charge at vesting, and the reverse is also true

A worked example and the foreign tax credit timing gap

Consider a US citizen co-founder living in London who subscribes for growth shares in a UK company at the price a valuer sets, with a leaver clause that lets the company buy back unvested shares at cost over four years. If both elections are made, the income at issue is nil or small in both countries, and later growth is capital gain in each.

When the company is sold, the UK charges Capital Gains Tax (opens the official GOV.UK page in a new tab) and the US taxes the gain in the same year. UK tax on the gain can generally be credited against US tax under the foreign tax credit (opens the official IRS page in a new tab) rules, claimed on Form 1116, subject to the limits and categories. Our post on selling a UK company as a US citizen covers the sale itself.

Change one fact. The founder signs the section 431 election but misses the 83(b) window. The UK has taxed the shares at issue and treats growth as capital gain, but the US taxes each tranche as compensation income when it vests, at its value then. There is little or no UK income tax in those years to credit, and the UK capital gains tax arrives years later on sale. Excess credit can be carried back one year and forward ten, but a mismatch of years and categories can still leave tax paid twice. Our post on which year takes the UK tax credit explains the timing rules. The reverse case, an 83(b) election without a UK election, produces a UK income tax charge at vesting with no US income in that year to set it against.

What the company and the founder should review

Beyond the elections, the company has UK reporting and may raise US information returns. Each is a point to review on the facts.

A UK company that issues shares to employees or directors reports them on its annual employment-related securities return to HMRC after the end of the tax year, and has to register the arrangement first. If US shareholders together control the company, it may be a controlled foreign corporation, and each US owner may need to file Form 5471 (opens the official IRS page in a new tab), which our page on Form 5471 and our post on Form 5471 for a one-person UK limited company explain. Net CFC tested income, formerly GILTI, and the options of a section 962 election or the high-tax exception are then worth reviewing. A company whose assets or income are mainly passive may be a PFIC, which would bring in Form 8621.

The UK side of the founder's position goes on the Self Assessment return, and the US side on Form 1040, which is due on 15 April with an automatic extension to 15 June for filers abroad. Our cross-border tax team reviews share terms before issue, and the guide for founders, fund managers and executives sets out how the other equity awards are treated. Keep these records together.

• The articles, subscription letter and any shareholders' agreement setting out the leaver terms
• The valuation used for the growth shares and the date it was prepared
• The signed section 431 election, dated within its window
• The 83(b) election or Form 15620, proof of posting and the copy given to the company
• Board minutes and share register entries showing the transfer date
• Later vesting dates, sale documents and exchange rates on each date