> I have all exercised options, but not all vested, been here about 2 years, so half vested. Didn't pay taxes at exercise because there was no difference between exercise price and market price.

Early exercise with a 83b election?

You will be fine.

The tax problem happens like this:

1. Your option strike price is $0.01/sh

2. The current price as set by the board (or the stock market if public) is $10/sh

3. You exercise 2000000 shares

4. You write a check to your company 2000000 sh * $0.01/sh = $20000

The fair market value (as determined in step #2) is 2,000,000 sh * $10/sh = $20,000,000

The IRS says "wait a minute you only paid $20,000 for something that is worth $20,000,000".

The difference $20,000,000 - $20,000 = $19,980,000 was a 'gift' that requires taxes to be paid.

Now lets do the 83b election with early exercise. In that case the FMV == the strike price on the options. The difference is $0 You are paying FMV and there is no 'gift'.

Thank you! The 83b situation is the one I'm in. Appreciate it, sorry for the late response.

If you exercised at market price then there's no tax liability. The shares are yours now; your exercise price is your cost basis, and you pay capital gains taxes when you sell on the difference between sale price and exercise price.

The situation that caught lots of employees in the dot-com bubble is that they exercised stock options where the market price at time of exercise was a lot more than the strike price (which means an income tax liability for the difference), but then there was a lockup and they weren't able to sell the stock until after it had dropped significantly. As a result, they had tax bills that were higher than the market value of the stocks they owned.

I had several friends and coworkers end up in this situation. Lucky for me, I started late enough that my options were underwater before my first year cliff and stayed that way...

I thought I understood this but the lockup that everyone in this discussion is alluding to has surprised me. Should the tax man not count the price of the security on the day the lockup ends as the strike price? Otherwise, any time you get discounted options with a lockup, it appears you should assume the options will go to zero and budget the tax accordingly. Or am I missing something?

The tax code counts the price at the time of exercise, not at the time the lockup ends. (A lockup is a contractual obligation not to sell the shares: you still own them, you just can't sell them.) The logic, I guess, is that there are other types of property (eg. real estate, private company shares, collectibles) that you may not be able to sell on a liquid market, but they are still items of value that you've received, and you should still be taxed on them at the time of receipt.

You could argue about the morality and rationality of this decision: some people would say it's both wrong and somewhat unfeasible to levy taxes that people have no way of paying. But that's the law for now. There are other scenarios that can get people into this situation as well: cryptocurrency transactions, property taxes, wealth taxes in general. Indeed, one reason we have Prop 13 in California is because seniors were being forced out of their homes because they couldn't pay the taxes, but that brought with it a whole bunch of other undesirable economic distortions.

From the employee POV, your best options are usually to either a.) file an 83(b) election as soon as you receive the stock options, indicating that you'd like to be taxed on their current fair market value (which is usually zero at the time you receive them, because most strike prices are set at the current market price) and have all future gains taxed as capital gains with a cost basis set at the time of the 83(b) election, or b.) don't exercise your shares until you're ready to sell them.

Did you file 83b election when exercising at market price? If yes, you already paid the taxes (which were $0). If not, there may be taxable income at vesting periods. Talk to tax professional. I'm certainly not one.

An 83b election is to be issued at the time of grant, not the time of exercise.

Honestly speak to an accountant - there are so many different ways you can get shafted on Tax for Options / Employee stock grants / Capital Gains.

Unlike the normal situation where you pay taxes when you sell an asset, with options when you acquire them any difference between the strike price and their value at acquisition is a taxable amount. If your acquisition occurs when you cannot sell because the shares are not publicly tradeable or because you are subject to a rule not allowing sales then in the time between when you acquire and when you could sell the stock can become worthless. This worthlessness has no effect on your tax bill which is finalized at the point of acquisition.

Yes, this is my understanding as well. You owe a lot of taxes initially (that you to pay to even exercise) and then you wouldn't pay AGAIN if the company goes bust.

That would, of course, suck, but you wouldn't "owe more" if the company goes bust. It would just be what you already paid now being worth less than what you paid for it.

I guess I don't understand the point being made with that in mind. If you took out a loan to exercise the options (don't do that), then that would be a big problem.

You only pay tax on the profit of exercised options