Let’s be honest. When you’re building a startup, tax planning is probably the last thing on your mind. You’re focused on product, funding, and survival. But here’s the deal: the financial choices you make now—especially around equity—cast a long shadow. Get them right, and you save a fortune and a world of stress. Get them wrong, and you could face a massive, illiquid tax bill. It’s like building a brilliant app on a shaky server foundation. Why risk it?
This isn’t about complex loopholes. It’s about understanding the lay of the land. We’ll walk through the key strategies that give you control and keep more of your hard-earned equity where it belongs: with you.
The 83(b) Election: Your First and Most Crucial Move
If you remember one thing from this article, make it this. The 83(b) election is a foundational tax planning strategy for founders receiving restricted stock. Honestly, it’s a bit of a superpower if you time it right.
Here’s the typical scenario. Your company grants you shares that “vest” over four years. They have a low fair market value today (say, $0.01 per share). Without an 83(b) election, you’re taxed on the value of the shares as they vest. If your startup’s value skyrockets, you owe ordinary income tax on that increased value—even though you haven’t sold a single share. That’s a potential cash crisis.
Filing the 83(b) election flips the script. You choose to be taxed on the total value of the grant at the time it’s issued, when the value is minimal. That means you pay a tiny amount of tax now (often negligible), and all future appreciation is taxed as long-term capital gains when you eventually sell. The difference? Ordinary income tax rates can be over 37%. Long-term capital gains top out at 20%. That’s a monumental spread.
The catch? You must file the election with the IRS within 30 days of receiving the grant. It’s a strict deadline. Miss it, and the opportunity vanishes forever. It’s a paperwork sprint, but the payoff is huge.
Choosing Your Entity: More Than Just a Legal Formality
Sure, you picked a C-corp because investors prefer it. Or maybe an LLC for its simplicity. But each structure has distinct tax implications for you and your future team’s equity compensation.
C-Corporations: The VC darling. They allow for Incentive Stock Options (ISOs), which are a key tool for attracting talent. ISOs offer potential tax advantages for employees (like you) if certain holding periods are met. But C-corps come with potential double taxation—once at the corporate level and again at the shareholder level on dividends. For early-stage founders, the focus is usually on growth and exit, making ISOs a valuable currency.
S-Corporations & LLCs: These are “pass-through” entities. Profits and losses flow directly to your personal tax return, avoiding that corporate-level tax. This can be great for early profitability. But, they’re more limited for equity compensation. You can’t issue traditional ISOs. Equity grants are typically in the form of profits interests (for LLCs) or non-qualified stock options (NSOs), which have different, often less favorable, tax treatment upon exercise.
The choice isn’t just about today. It’s about where you’re going. A quick chat with a tax advisor who gets startups can save you a painful and expensive restructuring down the line.
Demystifying Equity Compensation: ISOs vs. NSOs
As a founder, you’re likely granting options to early employees. And you probably hold options or restricted stock yourself. Knowing the flavor of equity you’re dealing with is half the battle.
| Type | Best For | Key Tax Trigger | The Founder’s Angle |
| Incentive Stock Options (ISOs) | Employees & founders (C-corps only). | No regular income tax at exercise (but may trigger Alternative Minimum Tax). Taxed at sale as capital gains if held long-term. | Potential for the best tax outcome, but complex rules. The $100K vesting limit per year can trip up highly-compensated founders. |
| Non-Qualified Stock Options (NSOs) | Consultants, advisors, anyone (any entity). | Ordinary income tax on the “spread” at exercise. Then capital gains on further growth at sale. | More flexible, but a bigger tax hit at exercise. You need cash to pay that tax. |
| Restricted Stock Awards (RSAs) | Founders & early key hires. | Taxed as ordinary income as shares vest (unless you file an 83(b) election!). | You own the stock outright, subject to vesting. The 83(b) is your best friend here. |
See, the pain point often isn’t the grant—it’s the exercise. An employee (or you) might have the right to buy shares at $0.10, now worth $10. That’s a $9.90 per share gain that’s taxable upon exercise for NSOs. Where does the cash come from to pay that tax? This “exercise financing” problem is real. Some companies are now offering liquidity programs or loan facilities to help, but it’s a puzzle you need to anticipate.
The AMT Trap with ISOs
We have to talk about the Alternative Minimum Tax (AMT). It’s the boogeyman of ISO planning. When you exercise ISOs and hold the shares (instead of selling immediately), the “bargain element” (the spread between exercise price and fair market value) gets added back for AMT calculation.
You could owe AMT even without selling a single share. In a high-growth scenario, this can mean a six-figure tax bill… for paper gains. It’s a classic startup horror story. Planning involves modeling AMT impacts before you exercise and sometimes strategically exercising in lower-income years.
Proactive Strategies Before the Exit Event
Thinking about taxes only when you get a term sheet is way too late. Here’s what to consider in the quiet, early days.
QSB Stock Exclusion (Section 1202)
This is a potential game-changer. If you hold stock in a Qualified Small Business (QSB) for more than five years, you may be able to exclude up to 100% of your capital gains from federal tax when you sell. The limits are high—up to $10 million or 10x your basis.
The rules are picky: it must be a C-corp with assets under $50 million, and it must be in an active trade or business (not a service firm or certain other exclusions). But if you qualify, it’s one of the most powerful tax breaks available. It makes early decisions about entity and stock issuance even more critical.
Charitable Remainder Trusts (CRTs) for Liquidity Events
If a large exit is on the horizon and you have philanthropic goals, a CRT can be a sophisticated tool. You contribute low-basis stock to the trust, the trust sells it tax-free, and you receive an income stream for life (or a term of years), with the remainder going to charity. It bypasses capital gains on the contributed assets and provides an immediate income tax deduction.
It’s not for everyone—it’s complex and irrevocable. But for founders with highly appreciated stock, it’s a strategy worth a conversation with your wealth planner.
Building Your Financial Foundation: Simple Steps Now
All this can feel overwhelming. So start simple. Build your foundation.
- Document everything. Grant dates, exercise prices, copies of every 83(b) election filed (and proof of mailing!).
- Get professional help early. Not just any CPA. Find one who specializes in startups. They’ve seen the AMT disasters and the successful exits. Their advice pays for itself.
- Model different scenarios. What if you exercise half your options now? What if the company valuation doubles before your next vesting cliff? Simple spreadsheets can reveal future cash flow needs for taxes.
- Talk to your team. Be transparent about the tax implications of their equity. It builds trust and prevents nasty surprises that can derail a key hire.
Look, building a company is a marathon of sprints. Tax planning is the part where you lace your shoes right, hydrate, and check the course map. It’s not the run itself, but it determines how you finish. The goal isn’t to become a tax expert. It’s to develop just enough awareness to ask the right questions and build a team that can guide you. Because the ultimate equity you’re building is in your own future—and that’s worth protecting with a clear-eyed plan.
