Why Having an ITIN and Filing an 83(b) Election is Critical for Startups with International Founders

Having a U.S.-based startup provides unparalleled opportunities for growth, but for international founders, understanding all the rules and regulations can be challenging. Among the most daunting considerations that I see foreign entrepreneurs struggling with, are obtaining an Individual Taxpayer Identification Number (ITIN) and filing an 83(b) election.

While these steps may not be necessary for every company, they can play a pivotal role in minimizing tax liabilities, help avoid costly compliance pitfalls, and improve financial control over your startup. Most importantly, filing the 83(b) election can save your company from needing to conduct expensive 409A valuations in the future. In this article, we’ll explore why international founders should prioritize obtaining an ITIN and filing an 83(b) election and how these steps can position your startup for long-term success.

What is an ITIN?

An ITIN (Individual Taxpayer Identification Number) is a tax processing number issued by the IRS for individuals who are not eligible for a Social Security Number (SSN). It is a nine-digit number that allows foreign nationals, non-resident aliens, and other individuals without SSNs to file U.S. tax returns and comply with U.S. tax laws. This number is essential for any non-U.S. resident who is involved in U.S. businesses or investments, particularly for those receiving equity or compensation from U.S. startups, but has become more challenging to obtain in recent years.

Who Needs an ITIN?

International founders who do not have an SSN but are involved with a U.S. startup, whether as owners, investors, or employees, will sometimes need an ITIN. You’ll need one if:

• You’re a non-U.S. resident with vesting ownership in a U.S. startup and plan to live in the U.S. during your vesting period.
• You’re entitled to income, dividends, or capital gains from U.S. sources and will need to file a tax return for this.
• You’re subject to U.S. tax withholding requirements and want to make sure the withholding is attributed to your tax account to receive a refund in a timely manner.

For many international startup founders, the ITIN serves as a critical identification number, allowing you to fulfill IRS reporting requirements and take advantage of tax benefits that may be available to you as a foreign national.

What is an 83(b) Election?

An 83(b) election is a provision in the U.S. tax code that allows individuals receiving restricted stock to elect to pay taxes on the fair market value of the stock at the time it is granted, rather than when it vests. When stock vests over time, it means the individual gains full ownership of the stock gradually, often over several years. Without an 83(b) election, the recipient would have to pay taxes on the stock each year as it vests, based on the stock’s increased value – leading to potentially large tax bills as the company grows.

Why the 83(b) Election is Crucial for Startups

For startup founders, filing an 83(b) election right away is vital because it allows you to pay taxes on the stock when its value is low or nearly zero, typically right after the company is founded. As the startup grows and the stock increases in value, you won’t have to pay additional taxes when the stock vests. This is particularly important in a startup environment where stock values can skyrocket quickly, leading to burdensome tax bills for U.S.-based founders who failed to file the 83(b) election.

But there’s an additional benefit for the startup itself: filing an 83(b) election early can also help you avoid the need for a 409A valuation. 409A valuations are required when issuing stock options to determine the fair market value of the company’s shares. Without an 83(b) election, every time a founder’s stock vests it could trigger the need for an updated 409A valuation, which can be costly and time-consuming. By filing an 83(b) election, you establish the stock’s value at the time of the grant, avoiding ongoing valuation requirements as the stock vests.

Why ITIN and 83(b) are Critical for International Founders

Now that we’ve outlined what an ITIN and an 83(b) election are, let’s dive into why these are particularly important for international founders – and why ignoring these steps can be costly.

1. Avoiding Double Taxation

One of the major concerns for international founders is double taxation: being taxed on the same income by both their home country and the U.S. government. An ITIN allows companies to properly report an international founder’s income to the IRS and take advantage of any tax treaties that may exist between the U.S. and their home country. These tax treaties often include provisions to prevent double taxation, meaning international founders can avoid paying taxes twice on the same income, and receive refunds for withholding paid in on their behalf.

By having an ITIN, you can also apply for tax refunds or credits, ensuring you are not overpaying on your U.S. tax liabilities. For those who delay obtaining an ITIN, missing out on tax credits or refunds can result in significant financial losses.

2. Facilitating U.S. Tax Compliance

Filing taxes in the U.S. is mandatory for foreign nationals who have U.S. source income or investments, including certain types of U.S. startups. Most often I see this triggered by ownership in LLCs which are pass-through entities by default. The ITIN serves as your personal identification number for tax purposes, ensuring that you can file your required tax returns and comply with IRS regulations. Without an ITIN, you risk penalties for failing to file your returns or for incorrect reporting of income.

This is especially important when it comes to the 83(b) election. Filing an 83(b) election requires submitting the election to the IRS, and having an ITIN is essential for international founders to ensure they can file it correctly. Failure to file the election properly could lead to significant tax consequences in the future, including triggering the need for a 409A valuation to establish stock value at each vesting period.

3. Maximizing Tax Savings

The 83(b) election is a powerful tax planning tool, especially for founders of startups that have the potential to grow rapidly in value. By paying taxes on your restricted stock upfront- when the stock’s value is low or non-existent – you can avoid paying taxes on the stock’s future appreciation as it vests. For international founders, this is an even more important consideration, as tax rates in your home country could be significantly higher than in the U.S.

Without an 83(b) election, the taxes owed on stock appreciation could significantly impact your ability to retain or sell your shares, potentially forcing you to sell a portion of your stock just to cover taxes. Making the election early ensures that you lock in the stock’s value at the time of the grant and can keep more of your equity down the road.

4. Avoiding the 409A Valuation Requirement

As mentioned, failing to file an 83(b) election can trigger the need for a 409A valuation- a complex and expensive process used to determine the fair market value of a startup’s stock. 409A valuations are not only costly, but they also have to be conducted regularly if stock is issued over multiple periods, typically quarterly. For startups that are trying to preserve cash and minimize expenses, avoiding this requirement can save both money and administrative headaches.

By filing an 83(b) election early, you establish the stock’s value at the time of grant, making it easier for the company to issue stock to employees and founders without having to conduct a separate valuation each time. This can streamline your company’s equity issuance process and save thousands of dollars over time.

5. Establishing Long-Term Compliance

For international founders looking to gain residence in the U.S. or continue operating their startups here, maintaining proper tax compliance is crucial. Obtaining an ITIN ensures that you can continue to file U.S. tax returns, while filing an 83(b) election positions you for long-term tax savings as your company grows.

Non-compliance with IRS regulations, such as failing to file an 83(b) election or neglecting to report income due to lack of an ITIN, can lead to audits, penalties, and interest on unpaid taxes. In extreme cases, these issues could jeopardize your startup’s financial health or your ability to remain in the U.S. as a founder.

Filing the ITIN and 83(b) Election

For international founders, obtaining an ITIN and filing an 83(b) election are essential steps for ensuring long-term financial success. These tax tools allow founders to avoid double taxation, maintain compliance with U.S. tax regulations, and significantly reduce future tax liabilities. Moreover, they help startups avoid costly 409A valuations, leaving more resources available for growth.

By taking the time to properly file for an ITIN and 83(b) election now, international founders can set themselves up for financial stability and focus on building their startups into the next big success. Taking these steps now will pay off in the long run, allowing you to focus on innovation and scaling your business.