[jypepin]

You usually are awarded stock options. A paper that gives you the right to buy stocks for a specific price. Those options (like most things employers will give you) are seen as income, because the employer give it to you as a reward for your work (just like salary).

So usually, when your company exits, that's when you then "exercise" your options (aka actually buy the stocks the options allow you to buy) and then sell those stocks.

Then: - Exercising the options triggers income taxes on the value of the stock you are getting (minus what you pay for it) - Selling the stock triggers capital gain (short term if you sell before 1 year, long term after holding them for 1 year)

A simple example: - You join and receive 100 stock options at $1. That means you can buy 100 stocks for $100 total. - Your company IPOs at $5 per stock. - You decide it's time to sell. You "exercise" your options -> so you spend $100 to buy 100 stocks at $1. Those stocks are worth $5 each, so you receive $500 in value. -> You get taxed on $400 of income (just like salary, bonus, etc). - You sell your stocks for $500 instantly. You get taxes short term capital gain on $500.

So you had in mind you'd make $500 (yayyy we IPO at $5 and I have 100 stocks) but you actually end up with ~$200 in your pocket.

[carlosdp]

This is if you exercise at/after the IPO. If you can afford it, you can exercise early, get taxed on that earlier value, and then it will be mostly capital gains. Higher risk, cause it could end up being worth nil, but higher reward.

[jypepin]

yes, there are a lot of other situations, but this is the general one and I was explaining the situation where why the person would not be paying capital gain tax

[carlosdp]

Yea, I was just adding on to your comment to shed light on why ISOs can be good in certain situations.