I don't understand why options are taxed at exercise. You aren't getting money out of the transaction. If you have an option to buy a share at $1 (when the share is valued at $10), and later you sell at $50, why isn't the tax treatment just that you have a $49 capital gain? Why do we instead do a $1 -> $10, and then a $10 -> $50 tax thing?
This is indeed what happens if the option itself (and not just the underlying security) is actively traded. [1] However in that case, when you receive the option, you have taxable income equal to the current FMV of the option (determined by looking at the market). To do the analogous thing with startup options would (a) result in employees getting taxed even earlier and (b) require using Black-Scholes or something to estimate the value of the option, resulting in "income" that is even more divorced from reality than the current status quo.
The stock is an asset that has value. This view makes a lot more sense when the stock is liquid and you can go and get rid of it right after you exercise your option.
I agree that this totally sucks if there is no easy/public market for the stock.
The option was an asset that had value as well. We do not generally charge capital gains on assets with values until they actually get turned into money. If a stock that you bought traditionally appreciates, or your house does, you don't pay cap gains on it unless you sell the asset in question.
I appreciate that in this case you're turning an asset into a slightly different asset, and that's not like just ordinary appreciation, but I don't know why it really matters. A rule of "capital gains gets charged when you turn an asset into cash" makes sense.
I think there is so way to abuse the shares by using them as collateral without having to sell them. I'm not sure of the details, but I'm pretty sure people found ways to take advantage.
