May 7, 2021
When you exercise your stock options (ISO, NSO), you will need to consider the tax implications to exercising. The employee pays taxes on the spread between your stock’s fair market value (FMV) and the current FMV at time of exercise. Non-incentive stock options (NSOs) are taxed at the same rate as your salary. Incentive stock options (ISOs) may be taxed through Alternative Minimum Tax (AMT).
If your employer allows you to early exercise (buying your shares before you vest them) then you could eliminate paying taxes when you buy your options all together. You can do this by filing an 83b election.
Early exercising and filing an 83b can save you a significant amount of tax in the future if the startup you are working at is successful. Here’s what you should know:
When you exercise your stock options you pay tax on the spread between the FMV on day your shares are granted and the current FMV when you exercise, but what if the current FMV on your exercise date is the same as the FMV on your grant date? Answer: there is no spread and as a result, no tax.
When you early exercise your option grant and file your 83b, you are asking the IRS to treat your unvested shares as fully vested. Rather than pay taxes on the day your shares fully vest, you can elect to pay taxes on the date of exercise. Or, to put it another way, you can pay taxes on your stock on the grant date versus instead of waiting until the stock is vested. The idea is that stock will rise in value over time so buying the shares earlier before the value rises will save you money on taxes, which means you could reduce your tax liability by paying on a lower valuation.
However, filing an 83b election is only available on stock options you receive with an early exercise option or as a restricted stock award (RSA). In addition, you may need spousal/partner consent to file an 83b election.
To file an 83b election, you’ll need to submit the form directly to the IRS and postmark it within 30 days of exercising your options. The best practice is to mail your form via certified mail and retain your proof of mailing. You must also submit a copy of the form to your employer.
As always, we encourage you to reach out to our team with your tax questions and to explore your options.