Early Exercise and 83(b) Election

Question

I am a long-term employee at a growing start up. I have a significant amount of non-qualified stock options, at very low strike price, fully vested and can be exercised at any time.(approx 1-2% ownership of the company, in my estimation)

I am interested in leaving and pursuing other opportunities, but as with most option agreements, the options will expire 90 days after I leave the company. As a result, I would have to exercise them to retain my stake. This seems like a good idea, as I am confident in the direction that the company is heading, and am confident that it will be profitable. Unfortunately, I do not yet have access to recent a cap table.

I have a few questions:

1. I assume I can/will need to file an 83(b) election, in order to avoid tax repercussions? What exactly will this save me from?
2. What steps should I take to (in the eyes of the law) guarantee that the board has received my execution notice? The secretary of the board is a notorious procrastinator and can be very unorganized.

Thanks in advance!

Answer 1

You mention "early exercise" in your title, but you seem to misunderstand what early exercise really means. Some companies offer stock options that vest over a number of years, but which can be exercised before they are vested. That is early exercise. You have vested stock options, so early exercise is not relevant. (It may or may not be the case that your stock options could have been early exercised before they vested, but regardless, you didn't exercise them, so the point is moot.)

As littleadv said, 83(b) election is for restricted stocks, often from exercising unvested stock options. Your options are already vested, so they won't be restricted stock. So 83(b) election is not relevant for you. A taxable event happen when you exercise. The point of the 83(b) election is that exercising unvested stock options is not a taxable event, so 83(b) election allows you to force it to be a taxable event. But for you, with vested stock options, there is no need to do this.

You mention that you want it not to be taxable upon exercise. But that's what Incentive Stock Options (ISOs) are for. ISOs were designed for the purpose of not being taxable for regular income tax purposes when you exercise (although it is still taxable upon exercise for AMT purposes), and it is only taxed when you sell. However, you have Non-qualified Stock Options. Were you given the option to get ISOs at the beginning? Why did your company give you NQSOs?

I don't know the specifics of your situation, but since you mentioned "early exercise" and 83(b) elections, I have a hypothesis as to what might have happened. For people who early-exercise (for plans that allow early-exercise), there is a slight advantage to having NQSOs compared to ISOs. This is because if you early exercise immediately upon grant and do 83(b) election, you pay no taxes upon exercise (because the difference between strike price and FMV is 0), and there are no taxes upon vesting (for regular or AMT), and if you hold it for at least 1 year, upon sale it will be long-term capital gains. On the other hand, for ISOs, it's the same except that for long-term capital gains, you have to hold it 2 years after grant and 1 year after exercise, so the period for long-term capital gains is longer.

So companies that allow early exercise will often offer employees either NQSOs or ISOs, where you would choose NQSO if you intend to early-exercise, or ISO otherwise. If (hypothetically) that's what happened, then you chose wrong because you got NQSOs and didn't early exercise.

Answer 2

I assume I can/will need to file an 83(b) election, in order to avoid tax repercussions? What exactly will this save me from?

83(b) election is for restricted stock grants, not for stock purchases. For restricted stocks, you generally pay income tax when they vest. For startups the price difference between the time of the grant and the time of the vesting can be astronomical and by choosing 83(b) you effectively pay income tax on the value of the grant instead of the value of the vest. Then, you only pay capital gains tax on the difference between the sale price and the grant value when you sell.

In your case you're exercising an option, i.e.: you're buying a stock, so 83(b) is irrelevant. What you will pay though is the tax on the difference between the strike price and the stock FMV (unless the stocks you end up buying are restricted - which would have been the case if you exercised your options early, but I don't think is going to be the case now).

What steps should I take to (in the eyes of the law) guarantee that the board has received my execution notice? The secretary of the board is a notorious procrastinator and can be very unorganized.

You should read what the grant contract/company policy says on that. Ask the HR/manager. Usually, a certified letter with return receipt should be enough, but you should verify the format, the address, and the timeframe.