Exercise before vesting to start the capital gains clock, with a 30-day filing deadline.
Most option plans include a provision allowing early exercise, the ability to purchase unvested shares before the time-based vesting schedule completes. You pay the full exercise price for all shares upfront. The shares you receive are subject to a repurchase right: if you leave before they vest, the company can buy back the unvested portion at your original exercise price. Economically, you've converted an option into stock, but the stock has a vesting restriction attached. The 83(b) election is what makes this powerful.
Without an 83(b) election, the IRS treats each vesting tranche as a new taxable event. You'd owe ordinary income tax on the spread as each batch of shares vests at a (likely higher) FMV. With an 83(b) election, you elect to be taxed today on the entire grant's current value, paying tax on a (hopefully near-zero) spread now and starting the capital gains holding period immediately for all shares. The election must be filed with the IRS within 30 days of the exercise date. This deadline is absolute. Missing it means losing the tax benefit entirely, with no exceptions.
Early exercise is most powerful when exercised early in a company's life, when the 409A valuation is low and close to the strike price, resulting in a near-zero spread at exercise and minimal immediate tax. At that point, you're pre-paying a small tax bill to convert years of future appreciation into LTCG rather than ordinary income. For ISOs, this also starts the qualifying disposition clock. If you hold for one year from exercise and two years from grant, all appreciation is LTCG. Early exercise becomes less attractive as valuation rises: the spread grows, the upfront tax bill grows, and the risk of paying tax on equity that later declines increases.
You lose the tax benefit permanently. Without the election, each vesting tranche will be taxed as ordinary income at the spread on the vest date. The IRS grants no extensions for missed 83(b) filings, and no subsequent action can restore the election. The 30-day deadline is one of the most consequential deadlines in private equity compensation.
Yes. If you early exercised and filed an 83(b), you paid tax on the FMV at exercise. If the company fails and shares become worthless, you can claim a capital loss, but you've already paid the income tax and the IRS's $3,000/year capital loss deduction limit against ordinary income means recovery is slow. This is the primary risk of early exercise, and why it's only powerful when the spread is near zero.
Yes, especially at low 409A valuations. Early exercise at a near-zero spread means minimal AMT exposure. The AMT preference item is small. The qualifying disposition holding period starts at the exercise date. If you hold for one year from exercise and two years from grant, all appreciation qualifies for long-term capital gains, often the best possible tax outcome for private equity compensation.
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