Stock Options and 83(b) Elections

Understanding stock options, 83(b) elections, RSUs, and equity compensation for employees.

Published January 1, 2022 ET

Exercising Stock Options

"When exercising stock options (ISO or NSO), the employee pays the taxes on the spread between the stock's FMV and the current FMV at the time of exercise."

Non-incentive stock options (NSOs) are taxed at the same rate as salary
Incentive Stock Options (ISOs) may be taxed through Alternative Minimum Tax (AMT) because an ISO is considered a Tax Preference Item

SecFi has a platform for financing these tax payments: secfi.com

Early Exercise

If your employer allows you to early exercise (buying shares before they're vested), you could eliminate paying taxes when you buy your options altogether. You can do this by filing an 83(b) election.

When you early exercise your option grant and file your 83(b), 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 the exercise.

The idea is that the stock will rise in value over time, so buying the shares earlier before the value rises will save you money on taxes.

The 83(b) Election

The 83(b) election gives an employee or startup founder the option to pay taxes on the total fair market value (FMV) of restricted stock at the time of granting.

Key points:

Applies to equity that is subject to vesting
Alerts the IRS to tax the elector for the ownership at the time of granting, rather than at the time of stock vesting
The 83(b) election documents must be sent to the IRS within 30 days after the issuing of restricted shares

Filing Requirements

To file an 83(b) election:

Submit the form directly to the IRS
Postmark it within 30 days of exercising the options
Mail via certified mail and retain your proof of mailing
Submit a copy of the form to your employer

When 83(b) Makes Sense

The 83(b) election makes the most sense when:

The elector is sure the value of the shares is going to increase over the coming years
The income reported is small at the time of granting

When 83(b) Can Backfire

If the equity value falls or the company files for bankruptcy, the taxpayer overpaid in taxes for shares with a lesser or worthless amount
If the employee leaves the firm before the vesting period is over, they would have paid taxes on shares that would never be received
With Early Exercise Options: some agreements allow the company to buy back unvested shares at the grant date value, meaning you'd have paid taxes on stock you now have to sell back

Missed the 30-Day Deadline?

Tactics for salvaging a blown deadline:

Cancel the Grant and Re-issue - restart the clock (but do not backdate stock options!)
Adjust the vesting language - If repurchase is at FMV (not grant price), there is no "Substantial Risk of Forfeiture" and 83(b) may not apply
Change the vesting schedule to vest immediately

Profit Interest

Profit interest refers to an equity right based on the future value of a partnership awarded to an individual for their service to the partnership. The award consists of receiving a percentage of profits from a partnership without having to contribute capital. Usually, this type of worker compensation requires an 83(b) election.

RSUs vs Options

RSU stands for Restricted Stock Unit. Unlike an option, it doesn't need to be exercised once vested.

Key characteristics of RSUs:

Assigned a fair market value (FMV) when they vest
Considered income once vested, and a portion of shares is withheld to pay income taxes
Employee receives the remaining shares and can sell them at their discretion
Don't provide dividends because actual shares aren't allocated (but employer may pay dividend equivalents)
Don't come with voting rights until paid out and converted into common shares
RSUs aren't eligible for the IRC 83(b) election