Interestingly, the recently passed tax reform bill seems to make this type of loss less likely - though it would seem to be too late for these employees.
https://www.towerswatson.com/en/Insights/Newsletters/Global/... (see section Private Company Equity Grants)
(Obligatory: I am not a lawyer, and none of my comments should be construed as legal advice.)
They didn't take real gains, they took illiquid paper gains and paid AMT (Alternative Minimum Tax).
Example: Strike price was $1 / share, "on-paper" price was $20 / share. Employee had 20,000 shares, with a "paper" gain of $380,000. They had to pay the taxes on those gains even though the stocks were not publicly traded and therefore illiquid.
> How else would you do it
The same way every other investment works: Tax the gains when the asset is sold.
Yes, I do. I think the whole notion that you pick and choose when to realise gains invites abuse.
This article explains the dynamics well: https://www.recode.net/2016/1/19/11588918/gilt-groupe-is-a-c...
In this case, one of the controversies is that company leadership may not have taken such a low sale price (given that they initially had offers of more than twice that) had they not been compensated with personal payoffs outside of the equity structure.
There's always the "they knew they could lose it!" line but if the leadership was lying internally and externally, I hope they get sued into oblivion.
I mean, it generally should be (in the sense that you exercise to sell) but some people don't realize that.
There is an exception around taxes for ISOs that recently became useful with the AMT change in the new tax law, but even in that case you often can't sell the share after you've exercised it without permission from your private company (which you are very unlikely to get).