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Comment by creaghpatr | Hacker News Reader

If a company (startup or otherwise) is private, then stock options holders can't liquidate their shares. However, they are still required to pay taxes on the capital gains when they exercise, which can be huge if the company has grown exponentially.

Not only do you have to take the risk of the stock/company crashing and burning but you have to pay in advance the taxes on the "gains" which you can't actually cash out. It's a trap, only thing you can do is stay at your company until liquidity occurs for shareholders.

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I don't think I fully comprehend - do stock options holders need to pay tax even if they have not added actual money to their bank account?

Why would someone have to pay in advance taxes on a gain that has not actually happened? If I don't have the money in my bank account yet, how can I pay this huge amount of gains tax even?

They exercise the options.

> Do stock options holders need to pay tax even if they have not added actual money to their bank account?

Yes. The options are converted into shares, which is considered a taxable event by the IRS. Ordinarily this isn't a problem because you can sell some fraction of the stock that you gained to pay for the taxes. But if the company is not public, you have no easy way to sell the shares.

> If I don't have the money in my bank account yet, how can I pay this huge amount of gains tax even?

That's exactly the problem. Many employees at unicorn startups are stuck in "golden handcuffs." If they leave, they oftentimes can't exercise their options due to the taxes, in which case they lose them. This forces them to stay in the hopes that one day the company will go public and they can exercise their options.

Just to make this clear (correct me if I'm wrong)... If you buy stock at market value, and it increases in value over time, you only pay tax when you sell it. But if you exercise a stock option (in which you purchase stock for a [typically] lower price than current value), the difference in value is considered the same as if you received any other non-monetary income (i.e, that difference in value is treated the same as a stock grant), in which you would have to pay tax in the current year. Did that about sum it up?

That's my understanding of it.

It's designed to prevent you from being able to defer taxation (interest-free leveraging of income you'd otherwise have paid in tax, essentially) or to reduce your taxation to the long-term capital gains rate.

I'm not sure if the authors of the AMT really considered how options with limited liquidity could create this bind.

Companies that grant options could fix this in a heartbeat by extending exercise windows; they choose not to do that. Nothing to do with AMT here.

If AMT repeal would 'fix' stock options, companies will change the terms to 'break' them again because they are handcuffs, not payments.

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