[dragonwriter]

> leading to a horror story of being taxed on a percentage of the millions of dollars you supposedly got but never realized a dime from.

If the shares a complete loss and liquidated that way, you also have a capital loss for the millions of dollars which can be applied against income for tax purposes; this may end up somewhat less than offsetting the tax bill depending on your other income because of tax rates; you do end up paying (for employer-provided options) the payroll tax for the spread in any case, but then, the main part of that is limited by the annual cap on SS taxes, so for most of anything in the millions, you'll only be paying, on the payroll tax side, the Medicare portion.

But, in any case, that risk (plus the long term capital gains benefit) is why, if you have confidence in the company, you exercise options as early as possible; you only delay exercise if your confidence in other uses of the money vs. the company's stock is such that the risk that you'll exercise at a point where the tax burden is higher is a cost worth paying for the other use of the money.

(Note also that if you get equity directly instead of in the form of options, you pay taxes -- payroll and income -- on the fair market value at the time you get the equity, too; which is equivalent to an option with a $0 strike price. So, its not like options that you choose whether and when to exercise are any worse in that respect.)

[geoelectric]

In the US, at least, the problem is that you realize the gain in a single tax year, but there's a limit on capital loss writeoffs so you have to spread that over a multi-year rollover. It doesn't balance.

Also, we have AMT (alternative minimum tax) which gets triggered by this kind of scenario--exercise and hold--and really ends up screwing you due to outdated but not updated calculations that assume anyone making over 150k or so is "rich".

[stygiansonic]

> If the shares a complete loss and liquidated that way, you also have a capital loss for the millions of dollars which can be applied against income for tax purposes; this may end up somewhat less than offsetting the tax bill depending on your other income because of tax rates; you do end up paying (for employer-provided options) the payroll tax for the spread in any case, but then, the main part of that is limited by the annual cap on SS taxes, so for most of anything in the millions, you'll only be paying, on the payroll tax side, the Medicare portion.

This depends on the tax jurisdiction; as the OP indicated, in Canada capital losses cannot be deducted against ordinary income, which the difference of (FMV - strike) would be assessed as. (I believe in the US, up to $3,000 of losses can be deducted against ordinary income)

[CPLX]

You can't necessarily offset the tax bill from the gains with the tax savings from the loss. That's the horrible "gotcha" scenario that makes everyone worry, and is in fact a real risk in these scenarios.

I looked around to find a overview of how this works with some case study examples, and this is the best I could come up with in 5 minutes of googling: https://www.sharespost.com/docs/the_stock_option_tax_dilemma...

[jeffbush]

I'm not sure your statement about "capital loss" is correct. I know people who have gotten burned by this. They still ended up writing a big tax check at the end of the year despite having worthless shares. The tax code is definitely not fair.

EDIT: other people have pointed out that capital loss is capped, which makes sense. So while it may be true that you can claim capital loss, my understanding has been that it never compensates for the tax you're already liable for when you exercised.