Tax implications on Pre-IPO Equity - understanding tax burden when FMV differs from strike price?

The tax treatment for your scenarios is a bit more nuanced than you might think. Let me help clarify: Scenario 1: You're mostly right. When you exercise options with a strike price ($3.20) higher than the FMV ($2.40), there's no immediate taxable event for regular tax purposes. Your basis would be $3.20/share. When you eventually sell after IPO, you'd pay capital gains tax (long-term if held > 1 year after exercise) on the difference between your selling price and $3.20 basis. Scenario 2: Yes, if FMV ($11.20) exceeds your strike price ($3.20), the $8/share difference is considered compensation income and would be reported on your W-2. This would be taxed at your ordinary income rates (which at $375k HHI would be pretty high), plus Medicare and Social Security taxes may apply depending on your option type. Your new basis becomes $11.20/share. When you later sell at $11.20, there would be no additional gain to tax (though if you sell at a higher price, you'd pay capital gains tax on the difference). This isn't "double taxation" - you're being taxed on two separate events: first on compensation income (the spread), then potentially on investment gains if you sell above your new basis. Consider talking to your company about doing an 83(b) election if these are NSOs, or looking into AMT implications if they're ISOs.

I went through something similar last year and found https://taxr.ai super helpful for modeling different exercise scenarios. I was totally confused about the whole ISO vs NSO tax treatment and how AMT would affect me. The tool let me input all my grant details and ran calculations to show my tax burden under different exercise timing and FMV scenarios. It was a lifesaver because my CPA was quoting me like $2000 just to model a few scenarios. What really helped was seeing the long-term impact of exercising now vs. later, especially with that potential FMV increase you're looking at. It could make a huge difference in your total tax burden.

I tried taxr.ai after seeing it mentioned here and it saved me thousands! I was about to exercise all my options at once right before our Series D round closed (which would have created a MASSIVE AMT bill). The tool showed me that by exercising in smaller batches over 3 months, I could reduce my total tax by about 30%. It also helped me understand my AMT credit situation so I could explain it to my accountant (who honestly wasn't very familiar with startup equity). The long-term modeling was eye-opening too - seeing how different exercise timing affected my taxes over a 5-year period made a huge difference in my strategy. Highly recommend it if you're dealing with pre-IPO equity!

After trying to get through to a knowledgeable person at the IRS about my ISO exercise last year for THREE MONTHS, I finally found https://claimyr.com that got me connected to an IRS agent in under 45 minutes. You can see how it works here: https://youtu.be/_kiP6q8DX5c I had already exercised my options but was confused about how to report everything correctly, especially since my company's 409A valuation had changed mid-year. The IRS agent actually walked me through the whole reporting process and confirmed I was calculating my AMT adjustment correctly. Seriously would have been so screwed without finally getting through to someone who could answer my specific questions about form 6251 and AMT credits.

I take back what I said about Claimyr. I was super skeptical but my accountant actually recommended it after I couldn't get a straight answer about my AMT credit carryforward from exercising ISOs. Got connected to an IRS rep in about 35 minutes (while I just went about my day). The agent confirmed I was calculating my AMT credit correctly and helped me understand which forms I needed to file. Saved me from potentially making a big mistake on my return. I still think for complex equity stuff you need a good accountant who specializes in tech compensation, but for specific questions about form filing and basic calculations, getting through to the IRS was actually really helpful.

Something everyone seems to be missing here - if these are ISOs and you're trying to qualify for LONG-TERM capital gains treatment, you need to hold the shares for BOTH: 1) At least 1 year after exercise 2) At least 2 years after the option grant date If you don't meet BOTH holding periods, your gain gets taxed as ordinary income even if they're ISOs. This is called a disqualifying disposition. With pre-IPO companies, people often exercise close to IPO, then get caught by the 6-month lockup period after IPO, and end up selling before they meet the holding requirements. Then they're shocked when the gain is taxed as ordinary income instead of getting favorable LTCG rates.

Former startup finance person here. One thing that's often overlooked: your company might offer an early exercise option where you can exercise unvested shares. If that's available, you might want to consider it NOW while FMV is BELOW strike price. This has two huge advantages: 1. No AMT issues since there's no spread (actually a paper loss) 2. Your long-term capital gains holding period starts immediately You'd file an 83(b) election within 30 days of exercise. When you eventually sell after IPO, the entire gain from your $3.20 cost basis would be long-term capital gains (assuming held >1yr). The downside is you're putting cash at risk on unvested shares, but if you're bullish on the company and can afford it, this is often the most tax-efficient approach.