This is great write up. Kudos to the author for taking the time. I did have a question about the following sentence:
>"If an employer gives you straight-up shares, then the IRS will tax the shares (at ordinary income rates) when they vest."
What would be treated as income and taxes here, the strike price x the number of options vesting? Is that correct? For regular worker bees this not very much though right? For instance say an employee has 25 shares vest in a quarter and their stick price is $20. 20 x 25 would be $500 more being taxes as income. Or am I completely not understanding something?
If it is not the strike price being taxes as income what is it, since the the value of an option is often unknown to rank and file employees let alone the IRS.
Shares vested x fair market value at vest. So you get 1000 shares when you join, worth $1/share. 250 vest on your first year, and that's when tax is due. But say the company grows and shares are $5/share. 5x250 is 1250 taxed income on the anniversary. Normally at early stages you're talking many thousands of shares though, that can increase rapidly.
The fmv is recalculated every year, or on any fundraise events. It needs to be a defensible number or the irs will be upset
>"The fmv is recalculated every year, or on any fundraise events."
This is the piece I was missing. Thank you for the clear explanation.
That being said it would be interesting to buy exercise them just to see what the company is actually valuing those options at, since this is often opaque to the average worker. I wonder if it's possible to exercise a single option and use it as a barometer of sorts to quantify you actual compensation? My guess is no.
I've never had a company refuse to give me the 409a valuation if I asked point blank for it(just say you're considering exercising and it's important for tax planning). It's important to keep in mind though they tend to purposely depress that value. But investors get a premium because their stock has legitimately more value than yours(liquidation preferences, board seats, etc). And without a liquid market, if you do sell privately you end up taking a large discount. I think the opacity is largely that it's difficult to value things, not so much nefariousness
I see, I guess you just need to know to ask for it. I imagine many(most?) do not. I find these discussions and these types of articles really helpful. I would like to think we are all becoming more savvy about these a result. Thanks for the tip.
But you can frontload all the "income" and taxes upfront. That's what an 83(b) election is: "Hi IRS, I'd like to pay/recognize this taxable event all right now, even before it vests".
So you get 1000 shares x $1/share = $1000 of income, and you pay taxes on it.
If they are options, and your company allows you to exercise early, then you can buy them and pay $1000 to convert to restricted stock, file an 83(b), and it's $0 in taxes as theres no gain. If they are just restricted stock(not to be confused with RSU) then you can 83(b) like you said. But any way you do it, including holding options, has a bunch of risk so every situation is unique.
>"If an employer gives you straight-up shares, then the IRS will tax the shares (at ordinary income rates) when they vest."
What would be treated as income and taxes here, the strike price x the number of options vesting? Is that correct? For regular worker bees this not very much though right? For instance say an employee has 25 shares vest in a quarter and their stick price is $20. 20 x 25 would be $500 more being taxes as income. Or am I completely not understanding something?
If it is not the strike price being taxes as income what is it, since the the value of an option is often unknown to rank and file employees let alone the IRS.