Early Exercise

What it means

Usually, you must wait for your stock options to "vest" (the time you must work to earn them) before you can buy them. Early exercise allows you to buy the stock before that time is up. You pay cash to own the shares immediately, even if the company still has the right to buy them back if you quit.

When you do this, you can file an 83(b) election with the IRS. This document tells the government you want to be taxed on the stock value right now, instead of later when the stock might be worth much more. This can help you lower your future taxes.

A simple example

Alex gets the option to buy 1,000 shares for $1 each. The current price of the stock is also $1. Alex uses early exercise to buy all 1,000 shares for $1,000 today. Because the price to buy the stock is the same as the price today, Alex owes $0 in taxes now. If the stock price rises to $10 in two years, Alex will have saved a lot of money because the tax was calculated when the stock was only worth $1.

Why it matters to you

• You can potentially pay lower taxes later if the stock price goes up significantly.
• You start the clock on your "holding period" (the time you own an asset) sooner, which helps qualify you for lower long-term tax rates.
• You must pay cash to buy the shares, and there is a risk the company will fail and your investment will lose its value.

Common mistakes to avoid

• Forgetting to file the 83(b) election with the IRS within 30 days of buying the shares.
• Spending money you cannot afford to lose on company stock that might never be worth anything.
• Not checking if your purchase triggers the Alternative Minimum Tax (AMT), a special tax meant to stop high earners from paying nothing.

Words used on this page

• 83(b) Election: A letter sent to the IRS saying you want to pay taxes on your stock when you get it, not when it vests.
• Alternative Minimum Tax (AMT): A backup tax system the government uses to ensure everyone pays at least a minimum amount.
• Exercise: The act of buying company stock using the options you were given.
• Holding Period: The amount of time you keep your stock before selling it.
• Vesting: The requirement that you work for the company for a certain amount of time before you truly own your stock.