but if the stock dropped in value, doesn't the loss in capital offset the taxes? Or has he _already_ paid the taxes, and cannot claw back any losses (since he has to offset those losses on future capital gains from other sources)?
It's the second. But someone getting 7 million in stock options should still be making bank somewhere and can probably offset it in the future. He's not really in that big of a pickle. Ultimately he will work out a payment plan with the IRS and pay it off over a few years.
He's also just an idiot. He should have sold enough stock to cover his taxes when he exercised the options. The people that get really screwed are those exercising options into illiquid companies. They may be paper millionaires as relatively junior engineers and have big tax bills. Then the company goes tits up and they lose everything without a reasonable expectation of future income high enough to offset their paper loss.
> It's the second.
No, it isn't? It can't be, because he's saying he can't pay the taxes. If he'd already paid them, they would already be paid.
Let's say you worked at Uber and you exercised ISOs at the IPO that had appreciated such that the bargain element at exercise was $1,000,000. You would owe 28% Federal + 7% California = $350,000 under AMT (ignoring a lot of other things for simplicity) in April 2020. When you sell your shares, you will be able to reclaim some of this tax through credits for AMT paid in previous years.
By the time the employee lockup expired in November 2019, the shares are trading 43% lower than the price you exercised at and are only worth ~$577K. You still have a $350K tax bill under AMT due in April 2020.
Because you exercised in 2019, you have an out - by selling the shares in a the same calendar year, you can lower the basis under AMT, but you give up the ability to pay long term capital gains rates on the sale (0-25% fed + 0-13.3% CA) and instead pay ordinary income tax rates (22-43% fed + 0-13.3% CA). Let's just say it would be 40% - you could reduce your tax bill to $231K by selling all of your shares.
You have until the employee trading window closes in mid-December to decide whether to hold onto your shares for the eventual preferential tax treatment, hoping they recover before the tax bill ruins you, or to double your tax rate to save money on taxes this year.
Now, the benefit of hindsight:
If you had sold all of your shares, you would have missed out on $330K in gains in the following 60 days. If you held all of your shares, you are still facing a hefty AMT bill and years of careful tax planning to reclaim the AMT credits you generated. Oh, and even if the shares 10x in value, you are still going to have >$100K in AMT credits that will probably take 10+ years to recover.
If I understand it correctly, the problem here is the lockup period? If you get options that you are guaranteed that you can sell immediately after exercising them, you should be good, right? Then the proper course of action is to exercise all you can, sell enough to cover your tax liability, and then do as you please with the rest, keep, sell, whatever.
But if you can't sell them on the exercise date, you have to start thinking about the bullshit you just described above, right?
For the exact example of Uber, yes. Getting rid of the lockup period is one reason companies have begun using direct listings instead of bank-backed IPOs. There’s no group of investors who want their cut before letting common shareholders sell their shares.