The 83(b) election, early exercising options before they vest

Disclaimer: this is not tax or legal advice, please consult your own experts.

In an effort to make the trade-offs a little clearer (and for my own reference):

This costs real money now, so why would I early exercise?

This is all about taxes.

FAQ’s

  • If you leave the company, unvested shares are still unvested, and the company will use its right to repurchase these early-exercised shares back (at the original strike price). Vested shares are yours, however you are given a limited time to exercise, called an “exercise period” — this has typically been 90 days, which can be very painful if you’re forced to choose to come up with a lot of cash within 90 days or not-exercise vested options. For this reason, some companies are starting to allow 10-year exercise periods (Adam D'Angelo has committed to this at Quora).
  • If the company fails the shares become $0 and you don’t get any of your original check back.
  • You can early-exercise a portion of your unvested options (it’s not all-or-nothing).
  • In both Scenarios, when you actually sell the shares that you own on the open market, you have to pay Capital Gains tax. If you had held this asset for >1 year, they you get to pay a discounted rate, “long term capital gains”, which at 15-20% is typically a much lower rate than income tax. With Scenario B, you get to use the date of early-exercise as the date the clock starts for calculating the “>1 year”.
    So in Scenario B, all shares received over the vesting schedule incur no income tax, and are all subject to the long term capital gains tax when you sell them.
  • You can ONLY early-exercise options that have not-yet vested.
  • You can early-exercise at any time prior to vesting. So in the example above, you do not need to early-exercise on 1/1/17, you can also wait to early-exercise on 6/1/17 or 12/30/17.
    However you must early-exercise at the current assessed value. So if you wait until 6/1/17, perhaps the company will have received a fresh new valuation at $0.50 per share. In which case when you early-exercise, you’ll pay $0.10 for something that’s worth $0.50, so in this year you have to recognize $0.40 per share of income.

The Logistics — what to do

If you would like to early-exercise, you MUST file some paperwork with the IRS within 30 days of the early-exercise.

  1. Send a cover letter and originally executed 83(b) form and one (1) additional copy via certified mail or Federal Express to the IRS, within 30 calendar days of the date of exercise, with a self-addressed stamped envelope. Retain receipt of mailing;
  2. One copy of the 83(b) form should be returned promptly to the Company for its records;
  3. One copy of the 83(b) form should be filed along with your federal income tax return for the year in which the 83(b) election is made; and
  4. The IRS file-stamped copy, when returned, should be retained.
  1. Walk early employees through this topic. It’s confusing, obscure, and important.
  2. Keep a ledger, a record of 83(b) forms and early-exercise checks you’ve received.
  3. Remember when you deposit the checks — this is not revenue.
  4. If the employee leaves before all of their options are vested, typically the company has to exercise your right to buy them back. This is not automatic. Here, the company writes the employee a check for the unvested options.

Resources:

This whole topic is sufficiently confusing to me that I had to read multiple sources that explain it in different ways. Feedback on the above, or additional resources below are welcome.

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