Only those who early exercise, or exercise their stock as it vests. They did this to try and optimize for long-term capital gains.
For most employees who leave their option grants as options, there is nothing to worry about.
When you are given a grant of stock options, you can sometimes ask the company to let you exercise it early, and vest the shares instead of the options. If you do this when the fair market value (FMV) of the underlying stock is the same as when the options are granted, you will not be in a precarious tax situation. However, many people wait a couple years before deciding to exercise their options, and as a result, they need to recognize a paper gain when they exercise later as the FMV is substantially higher. That's what happened here. They exercised later, thinking the stock price would go even higher, and they were wrong, but they had to pay taxes on that higher price.
While it's true they paid a lot of extra taxes, since they never recognized the gains, they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.
The premise of this argument is that the people who earned those options remain employees until the company gets liquid. If you leave, you're usually required to execute.
Correct me if I'm wrong, but even with an early exercise (or an exercise of vested options) where the valuation matches the strike price, that employee would still have had to personally fork over the amount needed to purchase the underlying shares. In the scenario described in the article, they've still lost a substantial chunk of money if the valuation is now a fraction of the strike price.
Secondly, while capital losses can be carried forward indefinitely, you can only apply ~$3,000 per year (as a deduction, not a credit).
1) you pay the strike, and pray the valuation continues to rise through any IPO, buyout, etc..
2) arbitrage - you pay the low strike, then sell in the secondary market for more, and hopefully realize a one-time profit after cost frictions.
From the article, sounds like most of the afflicted here were playing strategy (1), while there was some window to execute on (2) though many may have not noticed it.
> that employee would still have had to personally fork over the amount needed to purchase the underlying shares
Then what is the difference over just buying the shares outright as opposed to exercising options?
My understanding has always been that exercising options means getting a benefit (the shares) which has a value (the strike price) and you subsequently pay tax on that value.
You pay the strike price in cash and you get the shares. Your "basis" in the shares is the strike price (what you invested).
You base your AMT tax calculation on the difference between the fair market value and the strike price (that's the "phantom income").
When you sell the shares, your realized capital gains is based on the original basis and you may have AMT basis that's different.
If you exercise and immediately sell, AMT doesn't factor in.
Concretely (and picking semi-random numbers): If your strike price is $10/sh, the FMV is $25/share, and you have options on 1000 shares, you'd pay $10K to exercise, get 1000 shares, and have $15K in AMT income to consider.
If those shares later soared to $40 and you sold, you'd have a capital gains of ~$30K ($40K proceeds minus $10K basis minus commissions and fees).
If those shares instead crashed to $0, you'd have possibly paid AMT on the phantom income and you definitely lost the $10K in cash.
> they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.
IIRC it's only 7 years. For people who do a lot of transaction, that's enough. For employees that get to invest 3-4 years in a company to make a profit on equity, it's actually quite rare to make use of this.
Also, everyone keeps forgetting that even liquidity-event-induced-exercise very often doesn't come with the liquidity that makes it profitable: In the case of a public stock exchange event, the 6-month lock-up period required by SEC rule 144 (and/or the underwriters), the stock can go down 90%, which means you pay 15-60% taxes on imaginary gain, even if you played your cards perfectly. This one also applies to investors.
For most employees who leave their option grants as options, there is nothing to worry about.
When you are given a grant of stock options, you can sometimes ask the company to let you exercise it early, and vest the shares instead of the options. If you do this when the fair market value (FMV) of the underlying stock is the same as when the options are granted, you will not be in a precarious tax situation. However, many people wait a couple years before deciding to exercise their options, and as a result, they need to recognize a paper gain when they exercise later as the FMV is substantially higher. That's what happened here. They exercised later, thinking the stock price would go even higher, and they were wrong, but they had to pay taxes on that higher price.
While it's true they paid a lot of extra taxes, since they never recognized the gains, they can roll that tax credit forward to cover future gains they may get at some other point in the future. I'm not sure how long you can roll these losses forward, but I think it's for a substantial period of time.