
Ask HN: What are the tax implications of exercising startup options? - thrawoway
I&#x27;ve never been able to find a clear explanation of  this, and given Coinbase&#x27;s announcement today I thought it was a good time to learn.<p>So:<p>I get that if I leave my startup today I have 90 days to exercise my options.<p>I get that I&#x27;ll have to pay the agreed &#x27;strike price&#x27;<p>But everything after that is unclear to me.<p>Would I be paying tax as if I&#x27;d made capital gains in the amount of the delta between the strike price and the stock&#x27;s value today? Would the stock&#x27;s value today be based on the company&#x27;s valuation at the most recent round of funding?<p>If the company goes on to raise more VC funding, would I be liable in future years for the &#x27;capital gains&#x27; on this stock?<p>If the company went on to fail, would I be entitled to tax breaks for loss of stock?<p>etc.<p>I&#x27;d love to see a clear explanation of all this stuff from someone who&#x27;s been through it or just knows it. Thanks!
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yanda
1\. The day you exercise, the IRS will tax you _income tax_ on the value
between the stock's current value and your strike price. This is true even
though you haven't made money from selling the stock yet.

2\. If the company is still private, the stock's value is determined by the
last 409(A) valuation for Common stock that the company performed, assuming
that your options are for Common stock (which is very likely). The company
must perform one of these valuations a year and should provide you with that
amount upon your request.

3\. _Exercising_ the stock starts the clock for long term capital gains
treatement. That is, if you sell the stock a year after exercising it, you
will pay _capital gains_ tax on the value difference between the sell price
and the value at exercise.

Math wise:

* TP = strike price (the price in your option contract at which you buy the shares)

* EV = value of a share at exercise time, as determined by the latest 409A valuation

* SP = sale price of a share when you sell the stock eventually

* #S = the number of shares you have

* IT% = Your income tax rate

* CT% = Your long term capital gains rate

At exercise:

\- You pay to exercise the shares: #S * TP

\- You owe in taxes: #S * (EV - TP) * IT%

At sale

\- You make: #S * (SP - TP)

\- You owe in taxes, assuming you waited a year to sell: #S * (SP - EV) * CT%

~~~
kelukelugames
I have a nominal amount of options from the job I just left. The amount of
money doesn't sound like it's worth the hassle. Maybe I should just let it
expire.

~~~
jessedhillon
If you were granted ISOs (you were an employee and it is still within 90 days
from your departure) and they are still available to you as such, exercise
them as long as you're comfortable with the risk.

Despite the parent comment, unrealized earnings on the exercise of ISOs are
_not_ taxed as income.

~~~
sv123
They are not taxed as income but are subject to AMT, so can absolutely leave
you with a large tax burden if you aren't cautious.

[https://www.nceo.org/articles/stock-options-alternative-
mini...](https://www.nceo.org/articles/stock-options-alternative-minimum-tax-
amt)

~~~
hkmurakami
If it's a "token amount", then that's probably unlikely unless you have other
large deductions (ex: mortgage, property tax)

------
grellas
Here is a thread in which I explain various technical points relating to the
tax treatment of stock options:
[https://news.ycombinator.com/item?id=2623777](https://news.ycombinator.com/item?id=2623777)

Adding to this on your specific question about loss: when you exercise
options, your purchase price becomes the basis in your stock; if the company
fails and goes bankrupt, for example, you can deduct the amount of the basis
as a capital loss; this means you can offset this amount (i.e., deduct it
outright) against other capital gains you might have in that same year or in
future years (as part of a capital loss carryforward) but you cannot otherwise
deduct it outright; in general, federal tax law in such cases allows you to
deduct it at the rate of up to $3,000 in any given year, with the rest carried
forward for future potential deduction (this is the capital-loss
carryforward).

Hope this helps.

------
medmunds
I really recommend _Consider Your Options_ as a great source of clear info for
employees receiving any sort of equity compensation. One of my managers
introduced me to it about 20 years ago. Pleased to see they've been updating
it regularly since then.

[http://fairmark.com/books-fairmark-press/consider-your-
optio...](http://fairmark.com/books-fairmark-press/consider-your-options/)

~~~
Matt_Cutts
I stopped by to recommend this book too.

------
thrawoway
Here's another one: When should/shouldn't you exercise options when leaving a
startup?

Obviously, if you're leaving Uber you'd be wise to buy your vested equity if
you can.

Obviously, if you're leaving a company that is crumbling, you probably
shouldn't.

But what about an earlier, Series A/B startup that's promising but still shows
a lot of risk? Or what about a later stage startup that is doing well but not
on a guaranteed path to a huge exit? On what information would you decide
whether or not to exercise?

~~~
imh
At the same time, if I was an early Uber employee and the difference between
current value and exercise price is in the millions of dollars, then I'm on
the hook for a tax bill I can't afford. Are there any solutions beyond taking
out loans to pay my taxes?

~~~
refurb
Don't you have the option of sell to cover? You basically exercise all of the
options, then sell a proportion to cover the taxes?

~~~
hkmurakami
Uber doesn't allow secondary sales to 3rd party but will repurchase your
shares at their previous fundraising round price.

That's their current policy.

------
calcsam
Would I be paying tax as if I'd made capital gains in the amount of the delta
between the strike price and the stock's value today?

>> Yes, assuming you have not early exercised. This sucks.

Would the stock's value today be based on the company's valuation at the most
recent round of funding?

>> Yes, the 409A valuation, which is generally ~30% of the valuation you hear
about on TechCrunch for Series B-C companies. Investors received preferred
stock. You have common stock.

If the company goes on to raise more VC funding, would I be liable in future
years for the 'capital gains' on this stock?

>> Only when you sell it. Same as public stocks -- if you buy Twitter stock,
and sell it in 5 years after it's gone up 2x, you have to pay cap gains only
once after you sell.

If the company went on to fail, would I be entitled to tax breaks for loss of
stock?

>> Not sure. The rules around this are pretty complex. Ask a lawyer.

~~~
awwstn
Would I be paying tax as if I'd made capital gains in the amount of the delta
between the strike price and the stock's value today? >> Yes, assuming you
have not early exercised. This sucks.

>>>> So, if the company hasn't raised funding since I was offered my options,
would I have zero tax liability for exercising my vested options?

~~~
x0x0
No, the board can still increase the fmv value for two reasons:

1 - the company has executed well and increased their value;

2 - to ratchet golden handcuffs tighter

------
caseysoftware
This is the single best source I've ever read on options, exercising them,
etc: [http://www.amazon.com/Introduction-Stock-Options-David-
Weekl...](http://www.amazon.com/Introduction-Stock-Options-David-Weekly-
ebook/dp/B0055PQ4H8)

When I followed the recommendations (after checking with my accountant), I
saved thousands of dollars and I'm still benefitting from that even now.

My only criticism is that I wish I had read it about 2 years earlier.

------
hberg
Let me answer a question you haven't asked but that is very relevant:

Q: How can I mitigate the risk of holding startup shares that are illiquid and
whose value can drop to zero?

A: There are investment firms that will help you buy employee stock options
and then split the proceeds with you. One of these is ESO Fund (esofund.com)
and they are very nice people. They can help answer your other questions as
well.

------
BjoernKW
Pretty much depends on the country where you file your taxes. In general, you
pay taxes on the difference between the nominal value (strike price) and the
current market price of the shares because that's the compensation you
received instead of an ordinary salary.

What happens afterwards depends on both if you sell the resulting shares at a
profit or at a loss and when you sell them. Typically, taxation amounts to a
lot less if you hold the shares for more than a year.

See [https://turbotax.intuit.com/tax-tools/tax-
tips/Investments-a...](https://turbotax.intuit.com/tax-tools/tax-
tips/Investments-and-Taxes/Non-Qualified-Stock-Options/INF12046.html) for more
information on how this is dealt with in the US (including which tax forms to
file).

~~~
kemitche
I am not an expert.

That said, based on that article, there appears to be a difference between
Incentive Stock Options (ISOs) and Non-Qualified Stock Options. You linked to
information on that latter. Here is information on ISOs from Intuit:
[https://turbotax.intuit.com/tax-tools/tax-
tips/Investments-a...](https://turbotax.intuit.com/tax-tools/tax-
tips/Investments-and-Taxes/Incentive-Stock-Options/INF12049.html)

At a glance, ISOs appear to be more favorable, tax-wise, in the US - they
trigger AMT but not "direct" income tax.

------
jkarneges
You pay the strike price, and you pay taxes on the difference between the
current stock value and the strike price.

For example, if the shares would have been worth $1,000 when you joined the
company, then the strike price for the options is $1,000. If those shares
would be worth $10,000 at the time you exercise, then you pay $1,000 to the
company to receive the stock, and then you pay taxes on $9,000 (the
difference) to the government. So you might be looking at like 3K in taxes in
that case.

You owe the taxes for the current tax year. You owe the taxes regardless of
whether or not the company succeeds. Company could fold right after you
exercise and you'd still owe Uncle Sam 3 grand.

(Then there are also capital gains taxes to worry about after this. I am only
describing your immediate tax burden.)

~~~
chwahoo
if the company tanks right after you exercise, can't you deduct the losses?

~~~
stevewepay
This happened to a lot of people in the Valley after the dot com bust. They
exercised their options, triggering a tax liability, and then the shares
tanked, leaving them with no money to pay off the liability. They could only
deduct $3000/year. Lots of people were in a lot of trouble, but I remember
hearing that finally the IRS made a change so that this wouldn't affect you
anymore.

------
andreasklinger
Q: What are the downsides to Coinbase's approach?

------
erichurkman
Also, if you early exercise your shares, do not forget to file an 83(b)
election within 30 days of your exercise. This also applies if you end up
founding a company or are issued restricted stock awards.

~~~
kevinpet
If I understand the question correctly, and it's about what to do when leaving
the company, 83(b) is unnecessary. An 83(b) election says that you are
choosing to recognize paper gains today that the IRS would normally require
you to recognize when they are no longer subject to a substantial risk of
forfeiture. If he's leaving, he must be exercising vested options, so there is
no risk of forfeiture, so no need for 83(b).

An 83(b) election is critical for unvested stock, i.e. "early exercise".

------
hkmurakami
I have started to write a series of posts on my blog regarding this very
topic. So timely question.

> I get that if I leave my startup today I have 90 days to exercise my
> options.

The number of days to exercise depends on your contract. The typical number is
45 days. Pinterest's number for employees that have more than 2 years of
service is 7 years. This number is not set by law, and can be set to anything
the founders/investors agree to.

The 90 day number you are thinking of is the law stating that ISOs become
nonincentive options when not exercised after 90 days after termination of
employment.

> I get that I'll have to pay the agreed 'strike price'

You pay the "strike price" * "number of options you wish to exercise"

> Would I be paying tax as if I'd made capital gains in the amount of the
> delta between the strike price and the stock's value today? Would the
> stock's value today be based on the company's valuation at the most recent
> round of funding?

Assuming you were awarded ISOs, you do not owe capital gains tax under
"regular income tax" upon exercise. You only owe taxes upon sale of your stock
that you have attained through exercise, at some future date.

However, depending on your amount of gains, other income, and your effective
tax rate, you may owe tax under AMT. Consult a CPA with experience in this. It
should be simple for them. (I believe you get some tax credits for this AMT
payment when you end up selling your shares in the future)

The company's stock's value is set by the BoD meetings. This may or may not be
the same as the previous round of funding.

> If the company goes on to raise more VC funding, would I be liable in future
> years for the 'capital gains' on this stock?

You are only liable for "capital gains" when you sell the stock.

> If the company went on to fail, would I be entitled to tax breaks for loss
> of stock?

Good question! I hadn't thought of this one. My guess here would be "yes", you
would be able to claim a capital loss equal to the amount of money you paid to
acquire your stock.

------
desdiv
How does the tax situation change if you're a non-resident alien during the
whole process? Is there any difference in the tax rates?

------
philip1209
Another question along these lines, since OP's question seems well-answered:

If a startup employee has 90 days to exercise options after leaving a startup,
what happens if a liquidity event happens during that 90-day window?
Specifically, I'm wondering whether a cashless transaction is possible,
particularly if it is a cash deal.

------
bharad
This article is more than a decade old, but a lot of content is still
relevant. [http://web.mit.edu/tytso/www/OPTIONS-HOWTO/OPTIONS-
HOWTO.htm...](http://web.mit.edu/tytso/www/OPTIONS-HOWTO/OPTIONS-HOWTO.html)

------
thejerz
Many startups have a clause in their offer letter that promises to "recommend
that N options be granted at the next board meeting." It's a formality, but it
doesn't always happen. Make sure those options were actually granted before
you think about how to exercise them.

------
mtmail
Are you a founder with actual stock, or an employee with stock options? I
assume employee here.

As an employee if the company value is below the strike price you wouldn't
exercise your options because it leads to a loss. Exercising options is
voluntary.

If you use the options to buy stock and hold it then profits and loss are
subject to capital gains tax. Not sure what the minimum holding timeframe is
in the US. In my experience most employees don't have the amount of money to
buy the stock for long-term investment. To my best knowledge, losses are tax-
deductable. Remember even if you own stock there is hardly an open market to
sell like there is with publicly traded companies.

As an employee if you exercise the options and you make a profit then the
HR/payroll/accounting department will add that as income to the W2 and
transfer the money minus income tax to your account. When you do your taxes
you fill in the various fields of the W2 into your tax software. That's the
best case and usually just takes you a couple of signatures.

------
thrawoway
Also, please add more questions if you have them. I'm sure I didn't ask all
the pertinent ones, and if there's any place to find people who can answer,
it's probably HN.

~~~
mtmail
I'm glad you ask questions. I've worked with many people who didn't understand
the contracts they signed. Or thought they "owned" options (if the company
fires you you generally loose the options).

------
arturhoo
Is anyone able to give some insights for non US citizens that have options of
an American company but work overseas with no american employment contracts.
Thanks!

------
GFK_of_xmaspast
Go ask a professional instead of an internet chat forum.

~~~
andreasklinger
It's hard to find professionals who have better knowledge than the MAX() of
the people reading this thread.

Imo it's even hard (and costly) to find professionals who have enough exp in
general.

~~~
hamburglar
Agreed. I had an options exercise in the hundreds of thousands once and my tax
accountant, who came highly recommended but had relatively little experience
with options, completely screwed it up until I caught it. I got a new
accountant.

