Understanding ISO spread calculation - FMV vs strike price for pre-IPO stock options

Wait, I'm confused. My company also has ISOs and they told us the latest funding round price is what matters for taxes. Is that wrong? Also, what's the difference between 409A valuation and the VC round valuation? Aren't they the same thing?

The 409A valuation is specifically designed to determine the fair market value of common stock for tax purposes, and it's typically lower than the VC round price. VC investments usually purchase preferred stock with special rights and privileges, making it more valuable than common stock. Your company should be using the 409A valuation for setting strike prices and determining the spread for tax purposes. The latest funding round valuation is different - it reflects what investors paid for preferred shares with liquidation preferences and other rights that regular employees don't get with their stock options.

How exactly does taxr.ai work? I'm in a super similar situation but with NSOs not ISOs. Would it still help me? I've tried talking to my company's stock admin people but they keep giving vague answers about valuation.

I'm skeptical about these kinds of services. My company has a very complex cap table with multiple classes of shares. Can it really handle something that specific? Our last funding round had all kinds of weird terms.

Their system works by analyzing your specific grant documents and company valuation information. You just upload the paperwork and it pulls out all the relevant data automatically. They handle both ISOs and NSOs, so it would definitely work for your situation - the tax treatment is different but they cover both types. For complex cap tables, that's actually where it shines. My company had three different share classes and convertible notes. The platform accounts for all those factors when determining the true FMV and tax implications. It specifically looks at the details of your latest funding round terms to understand how they affect common stock valuation for tax purposes.

How does this actually work? I've called the IRS like 15 times about my stock options and never get through. Do they actually connect you with someone who understands ISOs and AMT stuff? Those topics are super specialized.

Yeah right. No way this gets you through to the IRS faster than waiting. I've spent literally hours on hold with the IRS and eventually just gave up and paid an accountant $500 to figure out my options situation. Sounds like a scam to me.

It works by holding your place in the IRS phone queue so you don't have to stay on hold yourself. When an IRS agent picks up, you get a call back immediately so you can talk to them. The average wait time for IRS calls is over 90 minutes, but with this I was connected in about 20 minutes. And yes, they can transfer you to specialized departments once you're connected. I specifically asked for someone who handles AMT and equity compensation questions, and after a brief hold I was transferred to an agent who dealt with those issues regularly. They answered my questions about how the ISO spread should be calculated and what documentation would satisfy the IRS if I were audited later.

Thanks for this explanation! Just to be super clear - even if the strike price equals the 409A valuation when I was granted the options, if I wait to exercise, I'd need to use whatever the 409A value is at the time of exercise for calculating the spread, right? So there's potentially a tax advantage to exercising earlier rather than later?

That's exactly right. The AMT spread calculation uses the FMV (from the 409A valuation) at the time you exercise, not when the options were granted. This is why many people choose to exercise early when the spread is smaller or zero. As your company grows and approaches IPO, that 409A valuation will likely increase significantly, creating a much larger spread and potentially a substantial AMT liability. Early exercise, if you can afford it, can be a smart tax strategy as long as you're confident in the company's future. Just remember to file an 83(b) election within 30 days if you exercise unvested options!

I exercised about $50k worth of ISOs last year with a spread of around $75k. It pushed me into AMT territory and I had to pay about $15k in additional taxes. But I'm hoping for a 5-10x return when we exit, so I figured it was worth the hit. Just make sure you have the cash set aside for those taxes - that caught me by surprise!

Thanks for sharing the numbers! That's really helpful. Did you do a partial exercise or all at once? I'm wondering if I should do a little each year to spread out the tax impact.

I did it all at once because I was worried about the valuation increasing quickly - we were in late Series B and I could see IPO on the horizon. In retrospect, spreading it out over a few years might have been smarter from a tax perspective, but I was concerned about missing the window when the spread was still manageable. One thing to consider is the AMT credit - you can carry forward unused AMT credits to offset regular tax in future years. So even though I paid that $15k hit, I'll get some of it back when I eventually sell the shares. The key is making sure you have enough cash flow to handle the immediate tax bill without creating financial stress.

This is really solid advice. I'm actually dealing with a similar transparency issue at my company right now. When I asked for the 409A valuation report, HR said they'd "look into it" but it's been three weeks with no follow-up. One thing I learned from talking to other employees is that some companies are reluctant to share the full 409A report because it contains sensitive information about the company's financial projections and assumptions. But they should at least be able to give you the per-share fair market value that's relevant for your options. @GalacticGladiator - you mentioned the 12-month update cycle, but I've heard some companies do them more frequently if they're raising money or expecting significant valuation changes. Do you know if there's a way to find out when the next 409A update is scheduled? That could help with timing the exercise decision.

This is exactly the kind of guidance I needed! I'm definitely going to send that formal email you suggested. It's frustrating that they're making this so complicated when it should be straightforward information. One follow-up question - if they do provide the 409A valuation and it turns out to be significantly higher than my strike price, is there any way to negotiate or challenge it? Or am I basically stuck with whatever number they give me for tax purposes? I'm worried about ending up with a huge AMT bill if I exercise, but I also don't want to miss out on potential gains if we go public soon. Also, has anyone here ever had their company refuse to provide this information? What are the actual consequences if they keep stonewalling?