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Dear Sir:

I have some questions regarding the pre-IPO stock options. I tried to read through your related messages, FAQs, and references, but I am just more confused. So if you can give me some answers just focusing on the pre-IPO stock option side, it would be great.

Let me first try to define the basics of the case. It is common to see a stock option package from a pre-IPO startup company structured as: the company awards, for example, 10,000 shares of stocks at 10 cents/share for over a period of 4 years. The employee will be able to vest 1/4 of total stocks after one year and vest 1/36 each month after.

My questions are, using the above example, the following:

Case 1: If the employee terminates his/her employment two years after the option is granted, he/she will be able to vest 1/2 of total shares, i.e., 5000 shares. The employee decided to exercise the stocks. So he/she paid $500 to buy the shares. If at this point, the company had gone through the one round of funding (but not IPO yet), which bumps up the company's valuation. How does this exercising of stock option affect his/her tax? Does he/she have to report any taxable income due to this? How does he/she determine the fair mocket value of the stocks?

Later if the company goes public, how does this affect the tax side?
On the other hand, if the company failed totally, how would that affect the tax side? Can he/she declare it as capital loss?
(assuming he/she didn't file 83b election)

Case 2: If the company allows employees to exercise their stocks any time with filing 83b elections, how does this affect the tax of an emploee, who decided to excise all shares (10,000) 2 months after joining the company (and filed 83b election)? How would the company's stock valuation (through different round od funding and IPO) at different times affect the employee's tax reporting? The stocks vest a portion each year, so how does the employee report his/her tax after 1,2,3,4 years of employment? (assuming that the employee was hired on Jan. 1 to simplify the discussion)

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