I've heard a variation on this that never quite made sense to me. Its possible that some relevant details were just lost in the retelling, and it goes like this:

The employee exercised his options shortly after an IPO, but before he could sell the shares. By the time he could sell the shares, the stock had fallen to the point that the proceeds from sale didn't cover his taxes due. It wasn't enough to drive them to the poor house, but it was the difference between making money and losing money.

Why would you exercise the options in this time window at all? What's the upside versus just sitting on them until the window opens up?

Why would you even be able to exercise the options in the trading blackout window? Doesn't that count as trading itself?

If both trades happened in the same calendar year, then wouldn't the capital loss from the sale wipe out the capital gain from the exercise, such that he only owed tax on the difference between the strike price and final sale price?

What am I missing from this picture?

The gap between your strike price and the current market value is ordinary income, not capital gains. The gap between the current market value at the time of exercise and time of sale is capital gains (or loss). You can only apply $3,000 per year of capital loss to ordinary income (but the remainder can be carried over to future years). AMT can also fuck you.

Suppose you have 1000 options with a strike price of $1, and your company IPOs at $10. If you exercise immediately you have $9000 of ordinary income. If a year later the stock is worth $0, you have $9000 of capital loss and can deduct up to $3000 of ordinary income for three years. If a year later the stock is worth $100 and you sell it, you have $9000 of ordinary income and $90,000 of long-term capital gains. If instead you wait a year to exercise your options and the stock goes up to $100, you have $99,000 of ordinary income and $0 of capital gains.

If your plan is to sell your stock ASAP, there's no reason to exercise before you can sell (unless your lockout is over a year or your options are going to expire), but if you plan to hold onto the stock then exercising at the lowest price you can is optimal tax-wise if the stock actually does go up.

Stock options are complicated and you should absolutely talk to a tax professional before doing anything with them.

> Why would you even be able to exercise the options in the trading blackout window? Doesn't that count as trading itself?

Exercising options isn't prohibited during a trading blackout, because it's not a market transaction. (Especially if you're only exercising with no sell to cover).

If your options are ISO, and you want to get the best tax treatment, it must be at least two years from grant and one year from exercise. If you joined around a year before the IPO, and you wanted the nice tax treatment, but to sell as soon as possible, then exercising near the IPO makes sense.

If you do sell in the same tax year (which isn't always a calendar year, many companies and some people have adjusted their tax year), then it's a capital loss (and a disqualified disposition), etc. But if the IPO is later in the tax year, the blackout may extend beyond, and you'ld owe AMT in one year, and maybe realize a big loss in the next. If you realized a big gain in the next year, you'd also get a big AMT credit, and things would work out; but the AMT credit isn't refundable, so it could take many years to get that back, more if you also lost your job because the company imploded.

Resignation can be a taxation event. If you’re getting taxed on the FMV of the options, you might as well lock in that price? You lose some cash, so that is a risk, but the big issue is taxation at resignation without liquidity. In Australia taxation at resignation stops being a thing on July 1st, thank god.

If you’re confident the sale of the stock in one year would net a profit, that one year between exercise and the sale allows for long-term capital gains treatment (usually 15% or whatever it is these days) vs short-term capital gains, which is taxed at your income level.

Worst case, it can be a 37% (federal) + 13% (CA) tax hit. Doesn’t make most people too happy, if you’re lucky enough to hit it that big.

Not a CPA, I’m sure there are different situations, but this is the simplest explanation I know of, from experience.

If you don't exercise them, you could lose them.

Why do people pay taxes that put them in real risk? Isn't the point of taxes to contribute financially to the continuance of the place that is doing something for you? I currently owe like 5 years worth of taxes, but paying it would compromise my well-being, so they can wait. Seems perfectly rational. If you have 50000 to pay in taxes, but only 10000 in savings and $3k a month in expenses, or even $50k in savings, only a small amount should be legally required from you. Maybe the U.S is different.

Not to say I'm not working on it though, but if paying taxes would put me on the street, guess what, I'm not paying them until whatever they pay for lets me live a life. Just like any other debt, if I'm put in a vulnerable position, debts don't get paid unless they someone else owns the thing I'm living in or depend on, or they can break my legs, like the bank. One could argue you shouldn't have made that particular risky financial move, or you shouldn't be taxed on reception of illiquid assets, which would also both be valid.

I have no idea where you're writing this from, but in almost any western country that I have any knowledge about what you're describing is wilfully committing a crime.

In the US, it's not a crime as long as you file your taxes accurately. The IRS generally allows you to set up a payment plan or even settle for less than is owed if it would cause hardship to pay.

Right, but you DO need to file the tax returns with the IRS, accurately reporting your income, and then actually negotiate the payment plan (and stick to it or renegotiate).

We don't just get to unilaterally declare that 'I'll be uncomfortable paying taxes, so it can wait'... and then not bother to file or negotiate a plan, which seems to sum up OP's position. Wish him/her luck, they'll need it!

Concealing income is a crime, delaying payment is not (though you will pay penalties and interest). It's quite easy to get a payment plan where you do this and don't risk garnishment or other collection efforts as long as you follow it.

As others said, as long as you're being transparent to authorities on how much you owe, it's typically not a crime - but it will likely attract interest and extra fees, possibly at punishing levels (depending on how you go about it).

In the end, it's in the interest of the State, like any other creditor, that you don't actually die of starvation (or worse). Getting a continued stream of money, even if smaller than you expected, is better than getting no money at all.

Who cares if it's not enforced? Granted, IRS does enforce, but apparently they take their time about it.

It's a crime only in US. Most civilized countries allows people to stagger their taxes.

In the US, if you owe taxes, you can negotiate a payment plan with the government. Not sure of the details of the story we are commenting on so I can't say anything about what may have happened. As far as I know, there is not need to end-up on the street. On the other hand, trying to personally manage a large tax debt is a huge mistake. You have to hire an attorney with experience in the domain or you are not going to have the best possible outcome.

in the US the IRS is pretty known for working with you - if you call theyll set up a payment plan or whatever.

ive known a number of people that got mildly burned by taxes, nothing crazy just unexpected, but with bigger numbers it could have been bad. When you have ISO(incentivized stock options), one of the incentives is you dont pay tax until you sell, which sounds great. There's this other way of calculating taxes, AMT(alternative minimum tax) which does not respect ISO, and you pay whichever is bigger. normally people dont get near AMT amounts, so most people dont know it exists. So when you exercise you think theres no tax, but then you do your taxes and realize actually you owe tax on money you never received.

Former boss told me a similar story from the first dotcom. He worked at Sun, things were looking great, a bunch of people vested and were paper millionaires. Two days later the market imploded and they were wiped out. He was one of the few who actually sold their equity straight away. Almost everyone else on his team now had a huge tax bill and nothing to pay it with. They went from thinking they were millionaires to bankrupt in less than a week.

> When exercising options, sell enough on the same day to pay the tax bill.

That assumes the stock is trading publicly or at least you can legally sell them.

In India most of the companies ask you to exercise your options within 2-3 months of quitting job. And most of them are not public companies. So there's a big dilemma. Exercise and take tax hit and hope that the company goes public and doesn't tank post IPO. Don't exercise and possibility of big regret. So..sort of a bummer.

Ironically (and sadly) two of the most publicised IPOs in India (PayTM and Zomato) have tanked since their IPO.

IPOs are a game of "let the institutional investors exit and leave retail holding the bag"

I'm not investing in any IPOs unless it's at fire sale prices, and I know my line in the sand where I will take a loss rather than hope and pray.

> IPOs are a game of "let the institutional investors exit and leave retail holding the bag"

The Rational Reminder podcast had an episode on them a little while ago:

> We’ve previously compared IPOs to lotteries that are prone to inflated valuations and low returns. Today we welcome “Mr. IPO,” Professor Jay Ritter onto the show for a deeper dive into IPO performance, for his insights into SPACs, and to hear his research into why economic growth doesn’t correlate with stock returns. Early in the episode, Jay unpacks how long-term IPO returns perform against first-day trading. While exploring the role that venture capital plays in tech IPOs, Jay talks about why negative earnings don’t affect tech IPOs in the short-term before sharing how skewness factors tend to impact young companies. Reflecting on how IPOs are usually underpriced, Jay discusses how the interests of companies are not aligned with the interests of IPO underwriters. After looking into IPO allocation, Jay compares the 2020 ‘hot IPO market’ with the internet bubble of the late 90s. Later, we ask Jay about what special-purpose acquisition companies (SPACs) are and why they’ve exploded in recent years. His answers highlight their investing benefits, risks, and why SPACs might be a better option for companies than IPOs. We examine how SPACs have historically performed and then jump into our next topic; why economic growth isn’t a good indicator that a country is worth investing in. He touches on why returns don’t correlate with economic growth, the place of capital gains and dividend yields when investing abroad, and how innovations in an industry can lead to higher stock returns. We wrap up our conversation by asking Jay for his take on whether the stock market is efficient before hearing how he defines success in his life. Tune in to hear our incredible and informative talk with Jay Ritter.

* https://rationalreminder.ca/podcast/139

They're generally not a good idea unless you're on 'the inside' and can get early access.

SPACs may be better for the companies, but the SPAC bear market of 2021 also shows that they can be horrible for retail.

> companies ask you to exercise your options

PS: when I say “ask you” it’s part of ESOP contract, the options expire if not exercised.

They ask you but are you legally obliged? What’s to stop you from not doing that.

Yes; it is stated in ESOP grant agreement contract. 1-3 months is the norm I've seen.

I had this situation back in the dot com crash.

I sold 2000 options in June. The following April I had to sell 15,000 to pay the taxes on the 2000. The following April I had to sell another 10,000 to pay the taxes on the 15,000.

If I had sold 20,000 instead of 2,000 and used that to pay taxes, I would have been in a far better financial situation.

Fortunately, I never went into the red, but I know people who did.

That didn't happen to me but I know multiple people in the same situation after the dot com collapse of 2000.

https://www.latimes.com/archives/la-xpm-2001-apr-13-mn-50476...

Your friend couldn't sell the shares and take a capital loss to offset the options gain?

I think it is employee options, something like chunk of options convert to real shares (say $1m). Tax man asks hey, where's my eg $220k? Employee says it's ok, I have $1m (in shares). Something happens on the market and shares are now worth $0 (or sub-$220k). They still owe the $220k!

Can you not take $1M loss? At one point, you had owned $1M of stock. It went to $0. That's a personal loss of $1M.

The 220k tax bill is on 'income' because it is employee compensation.

The 1M loss is 'capital gains' and therefore a separate category which cannot offset against the 220k income tax bill.

At least in Australia, capital losses do not entitle you to a refund on taxes owed or paid. They just just offset subsequent capital gains.

[IANACPA] without 83b election the $1M gain on stock options on the moment of exercise goes into regular income while the $1M loss would go into capital loss. The limit on loss offset to the income is $3K/year. So in the first year there would be $997K of regular income to pay taxes from and $997K carry over loss. Without any other capital gains to use the loss against, it would take another 333 years to write that loss down.

Example from [1], emphasis mine.

Suppose the stock market has a bad year. You sell a stock or mutual fund and realize a $20,000 loss with no capital gains that year. First, you'll use $3,000 of the loss to offset your ordinary income. The remaining $17,000 will carry over to the following year.

Next year, if you have $5,000 of capital gains, you can use $5,000 of your remaining $17,000 loss carryover to offset it. You can use another $3,000 to deduct against ordinary income, which would leave you with $9,000.

The remaining $9,000 will then carry forward to the next tax year. Assuming that you had no capital gains in the following three years, you could use up the remaining $9,000 loss, $3,000 at a time, over those three years.

[1] https://www.thebalance.com/can-a-capital-loss-carryover-to-t...

The $3000 stacks as an additional deduction from income. But if you had capital gains of $100k, that can totally be offset with a remaining balance of $900k. You can chew away your capital loss carryover with capital gains faster than 333 years.

Tax years is the issue I assume

I think the problem was he didn't get the tax bill until the next tax year. Selling the stock at a loss that year would not offset the gain from the previous tax year.

Well I hope your friend tried to work with the IRS. At the very least they can put tax debtors on a payment plan, but I would think that they could grant an exception to your friend to have the gain and loss cancel each other out even if they took place during different accounting periods. Never hurts to ask.

He did reach a settlement with the IRS, after all, the debt was more than his net worth. But he still lost everything and wound up in a trailer.

Oof, this sounds awful. This obviously doesn't matter now, but my understanding is that call/put options are not taxable if you exercise them[1], rather they get included in the cost basis for whatever you end up owning once you exercise. I can see your friend losing lots of money due to the price fluctuations, but hopefully he didn't pay tax he didn't owe.

I'm not a lawyer or accountant so if I'm wrong, happy to learn. :)

[1] https://www.investopedia.com/articles/active-trading/053115/...

Folks here are likely talking about employee stock options [NSOs and ISOs]. They've each got their pitfalls, but generally if you exercise them, you immediately owe tax [or AMT, depending--talk to an accountant first!] on the difference between your strike price and the current fair market value. If your employer's public, you know what that value is and can generally sell to cover your taxes. If your employer is private, you need to find out what the FMV is from your employer, and you still owe tax on it [if there's a gain], but you likely have no way of selling to pay the taxes.

Gotcha! That makes sense re: HN... Not sure why I assumed calls/puts, tbh.

They were employee stock options, not call/put ones. And yes, he had no idea he would owe tax on money he never had.

His tax bill was way more than his net worth.

I believe there were Illustra engineers who exercised options shortly after the Informix acquisition at the end of 1995 (at $36/share) but either couldn't immediately sell shares or choose not to thinking the stock value would go up. They owed taxes on their gains (about $30/share) but shortly thereafter the stock crashed leaving the shares worth less then the taxes owed. The stock only continued to decline in value after Informix restated earnings and the extent of their channel stuffing became known.

https://www.edn.com/toxic-accounting

https://en.wikipedia.org/wiki/Informix_Corporation#Phil_Whit...

That really sucks. I hope your friend is doing better now. :(

Well on the bright side he at least gets to carry the ST loss forward (indefinitely?)