Guide

How an 83(b) election can reduce your crypto tax bill by millions of dollars

November 22, 2023

How an 83(b) election can reduce your crypto tax bill by millions of dollars
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Key Takeaways

An 83(b) election form can have a life changing impact when you sell your vested token grants.

  • The 83(b) election is a provision in the tax code that allows you to pay ordinary income taxes on tokens before they vest.
  • You can save more than half of your total taxes from token grants by filing an 83(b) election form.
  • Employees who believe in the project will want to file 83(b) election forms to maximize their gains

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Disclaimer:The content of this blog is for informational purposes only and is not intended as legal, tax, or financial advice. Consult a professional advisor or get in touch with Toku for specific advice related to your situation. Toku is not liable for decisions made based on this content.

Today, roughly 29% of the global crypto workforce is based in the United States. This means a lot of people who are paid in crypto will be taxed in the United States by the Internal Revenue Service (IRS).

Here’s a likely story for many of you. You joined as an early employee of a crypto company. You’re living and working from the United States. As part of your compensation package, you were granted restricted tokens that vested over 4 years with a 1 year cliff. You worked hard on making the project a success. The token launches, the project does well and your token grant is now worth a lot of money. Congratulations! 

You sell your tokens. You see the money in your wallet. It’s tax season. You talk to your accountant. The first question your accountant asks you is, did you file an 83(b) election? You say no. Your accountant gives you a disappointed look and tells you, “you could have lowered your tax bill by millions of dollars if you filed this one specific form. Maybe next bull market, you’ll make sure to do it.”

The 83(b) election form can have a life changing impact on your exit liquidity. This allows you to pay taxes based on the original price of your token compensation at the time of grant, instead of the price when it vested.

In this article, we'll explore challenges and scenarios where individuals chose or didn't choose the 83(b) election, giving you a clearer picture of the implications and potential benefits.

What is an 83(b) election?

The 83(b) election is a provision in the tax code that allows you to pay ordinary income taxes on tokens before they vest. This will allow you to lock in the lower tax rates of ordinary income tax as compared to employment income tax.

When you file an 83(b) election, you are electing to be taxed on the current value of the tokens granted despite the fact that the tokens are still subject to vesting. You must file the 83(b) election form with the IRS within 30 days of receiving the tokens and cannot do so later.

If the token appreciates in value, this will mean that you will be able to save a lot of money on taxes. Essentially, you're proactively reporting income to the IRS to take advantage of a potentially lower tax liability before those assets have a chance to skyrocket in value.

By paying taxes upfront, you do take a risk. If the underlying tokens fell in value, this would mean you would pay more taxes than if you never filed an 83(b) election. Moreover, if you sell the tokens at a loss or the tokens become worthless, you cannot claim a refund back of the taxes you paid due to the 83(b) election

When your tokens become unrestricted, you will still be liable for capital gains tax upon liquidation of your assets, but the normal capital gains rules apply, so if you hold the token for more than a year after filing the 83(b) election, you will get capital gains treatment on the token sale.

How much can you save through using an 83(b) election?

Imagine two scenarios where you are granted 100,000 Restricted Token Award (RTA) or token options with the ability to exercise early, with 250 tokens vesting every year. The price of the underlying token increases every year from $10 initially, to $50, $100, $150 and $200 in subsequent years. 

  1. In Scenario A, you exercise immediately upon grant, file the 83(b) election, and then sell all your tokens when all your tokens have vested
  2. In Scenario B, you opt to not pursue an 83(b) election, and then sell all your tokens when all your tokens have vested.

Now, assuming an employment income tax rate of 30%, an ordinary income tax rate of 20%, and a capital gain tax rate of 10% to simplify calculations, let's see how much money you can save by using the 83(b) election:

HTML Table Generator
Aspects Scenario A Scenario B
Year 0 Grant amount: 100,000 tokens
Fair Market Value: $10
Taxable income: $1,000,000
Income Taxes: $200,000
No taxes were paid as RTA or options were not exercised early
Year 1 Vesting amount: 25,000 tokens
Income Taxes: No taxes were paid as RTA or options were already exercised early
Vesting amount: 25,000 tokens
Fair Market Value: $50
Taxable income: $1,250,000
Income Taxes: $375,000
Year 2 Vesting amount: 25,000 tokens
Income Taxes: No taxes were paid as RTA or options were already exercised early
Vesting amount: 25,000 tokens
Fair Market Value: $100
Taxable income: $2,500,000
Income Taxes: $750,000
Year 3 Vesting amount: 25,000 tokens
Income Taxes: No taxes were paid as RTA or options were already exercised early
Vesting amount: 25,000 tokens
Fair Market Value: $150
Taxable income: $3,750,000
Income Taxes: $1,125,000
Year 4 Vesting amount: 25,000 tokens
Income Taxes: No taxes were paid as RTA or options were already exercised early
Vesting amount: 25,000 tokens
Fair Market Value: $200
Taxable income: $5,000,000
Income Taxes: $1,500,000
At time of selling Tokens sold: 100,000
Average Purchase Price: $10
Average Sell Price: $200
CGT Taxable Amount: $19,000,000
Capital Gains Tax: $1,900,000
Tokens sold: 100,000
Average Purchase Price: $125
Average Sell Price: $200
CGT Taxable Amount: $7,500,000
Capital Gains Tax: $1,500,000
Total Taxes Paid $2,100,000 $5,250,000

As you can see, in the above situation, not filing an 83(b) election form would have meant that you would have to pay more than double (2.5x) the amount of taxes you could have paid.

This example illustrates how an 83(b) election can make a difference in your personal finances.

Conclusion

Navigating the complexities of token compensation can be challenging for early-stage companies and their employees. That's why crypto companies must have trusted partners to guide them through the different possible mechanisms that can optimize their token grant compensation plans.

Many crypto companies with existing agreements in place often need help making sure they have the right infrastructure in place to ensure grant recipients are able to file the 83(b) election.

At Toku, we're here to support you in every step of the way – no matter what token grant agreement you need to implement. With our expertise and Token Grant Administration platform, we make sure that you are fully briefed and have a clear understanding of your tax liabilities, implications, payment, and everything else you need to know to make informed decisions. We're committed to being their trusted partner in navigating the complexities of token compensation.

Make token grant administration simple today with Toku