What are the tax consequences of ISO exercising with an 83B election after the stocks FMV has gone up?

Question

I came across a lot of posts that talk about 83B and ISO vesting but still could not answer questions specific to my situation. I am trying to understand tax implications with exercising in the following situation:

I joined a startup a year ago and lets say I got allocated 4000 ISOs at $2. Now 25% have vested and the FMV is $10.

Since my company allows early exercising, If I exercise 2000 stocks now paying (2000 * 2 = $4000), What are my tax implications? Will I have to pay tax on (2000 * 8 = $16000) If so, Will it be a regular income tax or AMT or a short term capital gain?

Also, I read that 83B does not make sense for vested stocks. In the above case, can I file 83B for the unvested 1000 stocks? Whats the implication of not filing 83B on stocks that are unvested and exercised?

Answer 1

83(b) election is for restricted stocks, not options, so my answer assumes exercise at vest/at grant (early exercise).

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Will I have to pay tax on (2000 * 8 = $16000)

Yes.

Will it be a regular income tax or AMT or a short term capital gain?

You have no gain. You vested at $10 and sold at $10, you got a wash. The $16K you mentioned earlier is the benefit you got from the company, which is not a gain but your salary and is taxed as such (including FICA etc).

Also, I read that 83B does not make sense for vested stocks

Indeed.

In the above case, can I file 83B for the unvested 1000 stocks?

No, you can only file 83(b) election within 30 days from the grant.

By not filing it, you ended up with $16K being taxed at vest time as your salary (i.e.: at marginal rates). Had you filed 83(b) election on time, you'd pay the tax on your benefit (the $2 per option, if you didn't have to buy them), but all the gains on vesting would be capital gains (likely long term). That ship has sailed, for that particular grant.

Since in your case you can exercise the options, it is not as bad as it could have been. Consider a case where you got 1000 options at $0.01, they vested at $1000, you exercised them to get the stocks and you couldn't sell any (not yet public, can't sell privately, etc). You'd be taxed on $1M when you never actually received any cash income, and you'd have to chip out $300K on taxes on income you never had. By the time you could sell, the stocks can fall, say to $100, leaving you with hundreds of thousands of capital loss that you cannot deduct, and hundreds of thousands of taxes owed which you have no money to pay. That led to a lot of problems for people during the 90's .com bubble and the subsequent crash.

Answer 2

Undivided -

First, you said you had ISOs. ISOs are not taxed on exercise, unless you are subject to AMT. You would be taxed on disposition of the shares that you received by exercising the option. How you are taxed on disposition depends on a few things.

If you sell the shares within a year of exercising the option, OR within 2 years after grant of the option, then the "spread" on the date of exercise is ordinary compensation income, and any further gain is capital gain. If you hold the shares for at least a year after exercise AND two years after grant of the option, then upon sale of the shares, the full excess of FMV over the exercise price that you paid is taxed as long-term cap gain. (In effect, you've converted compensation to long-term capital gain.) If at the time of exercise, you were subject to AMT, then the "spread" is an item of adjustment for purposes of your AMT calculation even though it is not included in your regular income. (Speaking of AMT, you can make an 83(b) election with respect to the AMT treatment of the ISO spread. You can't do it for the regular tax, because section 83 is inapplicable to ISOs (see 83(e)(1)). But for AMT purposes, it's not treated as an ISO.

This is probably over and done with, since your question was from 2015. But, if the situation arises again with a future exercise, you'll have an idea where to start.