Please note that the following does not constitute legal or financial advice, is for information purposes only, and is subject to change. Do not rely on this information without first consulting a tax attorney or other tax professional.
Incentive Stock Options (ISOs) satisfy Section 422 of the IRS, and are tax advantaged. They may only be granted to employees of the company, and are ordinarily granted to the founders and early employees. The exercise price must be set at the fair market value (FMV) of the shares.
Tax considerations: ISOs are not taxed at exercise (so any “gain” on exercise is never taxed). Once exercised, the only tax event remaining would be the sale in the secondary market (remember, shares held at least 12 months will receive the more favorable long-term capital gain treatment).
Non-qualified (non-statutory) Stock Options (NSOs) may be granted to employees or independent contractors. They have no tax advantages. They enjoy no securities exemption and must be filed with state securities regulators prior to the grant unless the company has a class of shares traded on a national securities exchange.
Tax considerations: Tax occurs at exercise and is calculated as difference between FMV of the shares and the price paid. Once exercised, a second tax event occurs at the sale in the secondary market. A section 83(b) Election will accelerate the date the taxes are due so the individuals can pay all the tax up front at the potentially lower FMV.
Restricted Stock Units (RSUs) are becoming more popular (following 2008 when Microsoft used these in connection with Facebook). They enjoy no tax advantages. In fact, they are not even a stock "option." Rather, they just a way to grant units of stock to employees over time while encouraging retention due to vesting schedules over some period of months and years.
Tax considerations: Tax is due when the stock vests and is delivered. RSUs are taxed as ordinary gains. A second tax event occurs at the sale in the secondary market.
Section 83(b) Election allows individual to pay tax for an NSO or ordinary restricted stock plan (non-RSU) upon the grant of the stock rather than upon vesting. The election must be exercised within 30 days of the grant and is irrevocable.
An 83(b) Election reduces the potential tax liability (assuming FMV is increasing) but is risky (e.g. if the employee quits, there is no way to get the tax back from the IRS).
For RSUs, a Section 83(b) Election can only be made upon vesting. The individual would use FMV to determine the tax liability.