# The 83(b) election, early exercising your options before they vest

This is one of those topics that early startup employees and founders should get right, but I always find it frustratingly hard to nail the details correctly.

In an effort to make the trade-offs a little clearer (and for my own reference):

If you are an early employee at a startup (e.g. you’re getting options with a very low exercise or “strike” price) and if you’re paying taxes in the U.S., then you have an opportunity to “early exercise” your not-yet-vested options. Assuming that your options are granted on a vesting schedule, you are able to pay the strike price BEFORE your options vest.

Example:
On Jan 1, 2017 you’ve been granted 30,000 options = the right to buy 30k shares at a price of \$0.10. And this right is granted over time (4 years, the 1st 25% vested on your 1 year anniversary).
Scenario A: You can do nothing, and just wait for your options to vest
— OR —
Scenario B: You have the opportunity “early exercise” these options — that is, write the company a check for \$0.10 * 30,000 = \$3,000 right away, while the assessed market value of the company is still \$0.10 per share.
This does not accelerate or change the vesting schedule, and so if you exit the vesting schedule before 1/1/18 (let’s say you leave the company), then the company will exercise its right to repurchase the unvested shares from you at the original strike price, \$0.10 per share.

### This costs real money now, so why would I early exercise?

Imagine it’s now 1 year later, Jan 1, 2018. The assessed market value of your company has now risen to \$1.00 per share, whereas on 1/1/17 it was \$0.10.

Scenario A: you’ve done nothing and just waited for your options to vest:
* On Jan 1, 2018, you receive your 1st vest: 7,500 options, i.e. the right to buy 7,500 shares at a price of \$0.10.
* So you have received the option to buy 7,500 shares worth \$1.00 each for \$0.10. Options vesting are not a taxable event.
* But if you were to exercise these options (paying \$0.10 for shares worth \$1.00), as the IRS is concerned, you’ll have received (\$0.90 * 7,500) = \$6,750 of income. This is subject to income tax (the amount depends on your tax bracket and an even more complicated thing called the alternative minimum tax).

Alternatively…

Scenario B: you’ve “early exercised” these options on 1/1/17:
* On Jan 1, 2018, you receive 7,500 options, i.e. the right to buy 7,500 shares at a price of \$0.10.
* However you’ve already previously pre-paid for these options. You paid \$0.10 per option a year ago, when the assessed market value was still \$0.10. At the time of early-exercise, you paid \$0.10 and received something valued at \$0.10, so you’ve received \$0 in income, and so you had \$0 in extra income tax last year.
* Now on 1/1/18, 7,500 options vest, you already early-exercised them a year ago, so these are immediately “exercised” into shares. At this moment, you have on paper something worth \$7,500.
* You pay NO income tax on this (by pre-paying last year, you get to recognize the transaction as \$0 of extra income last year).

This is a bet that you make, before your options vest, that the company is successful enough that the future difference in tax treatment is greater than what you pay upfront.

Said another way (thanks Job Evers-Meltzer): by not exercising early, you give yourself the option to wait and see how the company does in the future. If the company shares do not become more valuable than your strike price, you don’t exercise and save yourself that money. If the company shares do very well, you then exercise but incur the income tax burden.

You can play out the above scenario for every subsequent vesting date.

This scenario gets more dramatic if you and the company are wildly successful. For example, run through the above math at \$100 per share rather than \$1.

### FAQ’s

• If you leave the company, unvested shares are still unvested, and the company will use its right to repurchase these early-exercised shares back (at the original strike price). Vested shares are yours, however you are given a limited time to exercise, called an “exercise period” — this has typically been 90 days, which can be very painful if you’re forced to choose to come up with a lot of cash within 90 days or not-exercise vested options. For this reason, some companies are starting to allow 10-year exercise periods (Adam D'Angelo has committed to this at Quora).
• If the company fails the shares become \$0 and you don’t get any of your original check back.
• You can early-exercise a portion of your unvested options (it’s not all-or-nothing).
• In both Scenarios, when you actually sell the shares that you own on the open market, you have to pay Capital Gains tax. If you had held this asset for >1 year, they you get to pay a discounted rate, “long term capital gains”, which at 15-20% is typically a much lower rate than income tax. With Scenario B, you get to use the date of early-exercise as the date the clock starts for calculating the “>1 year”.
So in Scenario B, all shares received over the vesting schedule incur no income tax, and are all subject to the long term capital gains tax when you sell them.
• You can ONLY early-exercise options that have not-yet vested.
• You can early-exercise at any time prior to vesting. So in the example above, you do not need to early-exercise on 1/1/17, you can also wait to early-exercise on 6/1/17 or 12/30/17.
However you must early-exercise at the current assessed value. So if you wait until 6/1/17, perhaps the company will have received a fresh new valuation at \$0.50 per share. In which case when you early-exercise, you’ll pay \$0.10 for something that’s worth \$0.50, so in this year you have to recognize \$0.40 per share of income.

### The Logistics — what to do

If you would like to early-exercise, you MUST file some paperwork with the IRS within 30 days of the early-exercise.

Fill out multiple copies of an 83(b) Election Form (one example, note if you’re married this includes a spousal consent signature).

1. Send a cover letter and originally executed 83(b) form and one (1) additional copy via certified mail or Federal Express to the IRS, within 30 calendar days of the date of transfer, with a self-addressed stamped envelope. Retain receipt of mailing;
2. One copy of the 83(b) form should be returned promptly to the Company for its records;
3. One copy of the 83(b) form should be filed along with your federal income tax return for the year in which the 83(b) election is made; and
4. The IRS file-stamped copy, when returned, should be retained.

If you are a company founder or someone responsible for new early employees, I highly suggest creating a little system:

1. Walk early employees through this topic. It’s confusing, obscure, and important.
2. Keep a ledger, a record of 83(b) forms and early-exercise checks you’ve received.

### Resources:

This whole topic is sufficiently confusing to me that I had to read multiple sources that explain it in different ways. Feedback on the above, or additional resources below are welcome.

Official statements from the IRS: