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.