Early Exercise and the 83(b) Election

What early exercise is

Some startups let you exercise options before they vest. You pay the strike price and receive restricted shares, which the company can buy back at your cost if you leave before they vest.

What the 83(b) election does

Normally, restricted stock is taxed as it vests, on its value at each vesting date. An 83(b) election tells the IRS to tax it now, based on today's value.

If you exercise when the strike equals the current 409A value, the spread is $0, so the 83(b) creates no tax at all. Future growth becomes capital gain instead of ordinary income or AMT.

The 30-day deadline

You must file the 83(b) with the IRS within 30 days of the exercise, and there are no extensions. The IRS now accepts it by mail or through your IRS online account. Keep proof of filing and give your company a copy.

Benefits

• Holding periods start now. Your capital gains clock starts, and for ISOs so do the 1-year and 2-year clocks.
• QSBS clock starts. If the stock qualifies, the holding period for QSBS starts at exercise.
• No AMT later. For early-exercised ISOs, the AMT spread is measured at exercise, usually zero.

Risks

• You can lose the cash. If the company fails, the strike price is gone. A capital loss is small comfort.
• Leaving early. The company buys back unvested shares at your cost. Any tax you paid on a non-zero spread isn't refunded.
• Cash up front. You pay for shares that may not be worth anything for years.

When it usually makes sense

• Very early in a company's life, when the strike is low.
• When the total cost is an amount you could afford to lose.
• When you expect to stay at least through the cliff.

Not available for RSUs

RSUs aren't property until they settle, so there's nothing to make an 83(b) election on.

General information, not tax advice.