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Comment by shams93 | Hacker News Reader

Its taken them a while, all their peers except for Amazon have essential gone to the dust. If Geocities had been bought by say Google instead of Yahoo I could have easily flipped my options into my own startup. However dot bomb hit so hard instead of wealth I was left holding a huge capital gains tax bill that forced me into 10 solid years of hardcore poverty as most of my income was confiscated to pay off the debt. Not a nice outcome for companies bought by yahoo back in the 90s!

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Have you written more about this? I would love to read more details.

One person who avoided this was Mark Cuban, who bought a bunch of Yahoo! put options when broadcast.com was acquired, hedging himself against the stock crash.

Nice strategy. I wonder why others didn't do it.

If you read Mark's story, it's clear that he was aware of what was happening at the time but didn't drink the kool-aid, while if you look at the other dot bombs, they definitely thought the world was changing and the rules had changed.

"Read his story" --> Can you provide a link to this particular story? I would be interested to read it.

http://investmentxyz.blogspot.ch/2006/05/cubans-collar-anato...

What it seemed like to me reading over the stories of Mark Cuban was that he realized (with the help of some frugal advisors) that he just made a ton of money on paper and didn't want to lose out transferring that into real actual dollars in the bank. It just seemed he had different goals than everyone else: everyone around him wanted to get as rich as possible, Cuban seemed to want to have as much money in his bank account as possible. Two very different things.

Most people have no idea how to buy puts or collars.

When you just sold your company for a billion dollars, there's no excuse to be ignorant of all the options (ha) at your disposal. If you don't know about puts or collars, you should have an advisor who tells you about them.

haha true. However was the parent who referenced geocities selling a lot of shares or a small amount? I bet someone selling under a million $ in shares might not have the same advisory level as Mark Cuban.

I should. At the time, you got your stock option, if you were like me, just out of school, you really didn't have the resources to make moves like Cuban.

How do you not make money and still owe a lot in capital gains?

Generally this occurs when you exercise an option to purchase stock, then hold the stock while it significantly depreciates in value. Fairly common scenario during the dot-com bubble.

1) Option at $1

2) Exercise at $100, spending $1 to buy. Tax on $99 short term capital gains owed, or ~$35.

3) Stock falls to $10 and sold for a $9 profit. You still owe $35 capital gains and spent $1. Net loss of $25 per share.

Did you mean "2) Exercise at $100 [..]"?

Wouldn't the prudent thing to do be to sell at least enough stock to pay the tax? If not allowed to sell at that point- just short stock to have the equivalent effect (minus fees)?

Something else I've never understood to be rational - If you wouldn't buy $10 in yahoo stock- why would you hold it because you have it?

My uninformed but seems logical answer would be sell the stock you got, pay the tax and buy and index fund.

The stock needs to be public by the time you exercise to be able to do this.

When Yahoo bought Geocities, both were public.

> Wouldn't the prudent thing to do be to sell at least enough stock to pay the tax?

It's not liquid yet, that's the issue. That's what is nice about most RSU plans -- they immediately sell to cover, so you don't receive a ton of stock with an attached tax bill.

But illiquid options are different; the capital gains tax is for the paper-wealth you just received. That same paper wealth can evaporate, but the tax bill remains.

So you have an asset that is considered worth a price, but you cannot buy it or sell it at that price? Seems to me an unfortunate tax policy.

It's the exercise and hold that gets you. If you do a same day sell, you have the money to cover the taxes immediately, since you sold. If you exercise and hold, you pay the money to exercise, and now owe taxes on the asset at fair market value of the assets when exercised, which you might not have because your bank account is actually decreasing. In the future, if the asset loses value, even if you sold all of it, you may still be left with a tax bill you can literally never repay.

Except you can't sell if the company is still private.

That's not true. The market it very illiquid, but you can sell it. Sharespost is one place.

The prudent thing is to only do cash-positive transactions, but that's easier said than done when the majority of your net worth is tied to your company.

Good Technologies is a good example -- any employee who purchased NSOs while they were still private got shafted: http://www.businessinsider.com/long-weird-history-of-good-te...

You're right but remember that this was happening during a period when it was really hard to not get sucked into the "irrational exuberance" with Yahoo being as much of a poster child as anyone.

I got burned in this way with my company's options but fortunately only a modest amount that I exercised and held. I had a fair number of total shared but fortunately they recovered somewhat over time and have been a good source of capital gains offsets in any case :-)

> 2) Exercise at $100 [1], spending $1 to buy. Tax on $99 short term capital gains owed, or ~$35.

This makes no sense. Simply exercising an option is not a taxable event--you're just trading a contract for shares of a stock. There's no money going into your bank account.

Furthermore, you aren't taxed short-term capital gains when you haven't realized a profit. You'd need to exercise AND sell at $100 / share for those gains to be taxable. The correct taxable amount in this scenario would be $9 / share ($1 spent, $10 earned, net gains = $9).

[1] Assuming you meant "exercise at $100" here.

Excercising an option is taxable under the AMT.

It may make no sense, but the IRS disagrees with you. Exercising is a taxable event.

That's only for ISOs, which are essentially deferred compensation. Getting paid in ISOs is functionally equivalent to taking an 83(b) election in that you're trading a risk of potential loss for the upside of only needing to pay long term capital gains tax.

You are confused.

Exercise of incentive stock options (ISOs) is not a taxable event, although you may get hit with the AMT. Exercise of non-qualified options (NSOs) is a taxable event. For both types of options, the sale of the stocks at a later time is taxable.

^ - this.

It may not make sense but that's the tax law. You will owe tax on unrealized gain in this scenario -- as others have said it's due to AMT. Check with your accountant.

This is why 83(b) elections are so important. If your employer allows you to early exercise stock you can purchase your options immediately, prior to vesting, and pay tax at that time. Because your option purchase price will be equal to the market value (409A) the net tax will be $0. The 83(b) election is how you declare you've paid the tax at exercise.

Sorry, but you are spreading dangerous misinformation. https://blog.wealthfront.com/exercise-stock-options-taxes/

You're right. I've asked the moderators to remove the comment. I was totally wrong here. Thanks for the link.

Well, you're right in the sense that it's absurd. :) But unfortunately it's also the law.

So if you exercise an option to buy a stock for $1, you have to pay taxes on the stock's current value, but if you had bought the stock outright at $1, you don't have to pay capital gains until you sell? That's absurd

Yes. Yes it is absurd. A lot of people have been screwed over by this situation.

I think it's basically a bug in US tax law. The scenario is such an edge case for most Americans.

The other not-so-nice aspect of this is that it disproportionately affects people who aren't already relatively wealthy. Theoretically you can avoid this trap by exercising your options as soon as possible and locking yourself into long-term capital gains. But if you're joining a relatively established startup it may well be pretty expensive to immediately exercise your options. If you don't have, say, 100k lying around you have to wait until there's liquidity, thus opening yourself up to this risk.

There are some downsides but this is one of the reasons that phantom stock and phantom stock options[1] can be good for employees as there is essentially nothing taxable until the actual payout, which is treated as regular income and can have taxes withheld like a normal bonus.

1. https://en.wikipedia.org/wiki/Phantom_stock

Phantom stock is super interesting. Do startups ever offer it? I'd be curious to know how it worked out.

It seems like it would be better than the worst case with traditional options but not as good as the best case. I mean, ideally you exercise your options early at a very low price and then enjoy long-term capital gains tax rates. Phantom stock means you'll always pay way more in taxes when you get your equity-based payout - 50%-60% vs 20%-30%. At the same time though you are never at risk of ending up underwater.

It seems like phantom stock would be great as an option for companies to offer employees - i.e. you could either get a traditional options structure or phantom stock. I wouldn't be surprised if there were negative accounting or tax consequences for the company though. And maybe the administrative overhead for offering phantom stock in addition to traditional options would be prohibitive for small startups.

I think purchasing an investment at below market value implies a subsidy and that subsidy is considered a gain, whether it's via options or not.

The key here is timing. In both cases you are buying the stock for $1, but in one case it's officially worth $100. Therefore, you have a taxable gain.

That much makes sense. What doesn't make sense is treating an illiquid value the same as a liquid one.

This sounds reasonable, however that subsidy/gain is already paid for with the employee's labor, which cannot be recovered. Paying taxes on what is essentially a guaranteed gain sounds reasonable, but when it is a gain earned by putting in labor over several years, I'm not sure this is the best solution.

> subsidy/gain is already paid for with the employee's labor

Salary is gain paid for with labor, and it is taxed. I'm not sure I follow your point.

Yes, salary is paid for with labor, but a reduced rate that is offset with compensation in the form of stock options. You're correct that it is taxed, and the capital gains rate is lower than the salary tax rate. My comment was more an observation, but the thought hadn't been fully fleshed out.

Ugh. The era before amt credits was bleak.

Yup. A lot of Yahoo's impaled themselves on "exercise and hold". "Same day sale" ended up being less risky.

oh man the US tax code is so f*cked

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