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What happens when after exercising, you sell the shares for a lot lower than the EV the year after? Can you claim a loss and deduct the loss from the taxable income the year you sold?

Is your tax deduction = #S * (EV - SP)?

Tax deduction is #S * (SP - Sale Stock Price).

This is equivalent to the standard: (Cost Basis - Sale Proceeds) calculation in a standard stock transaction.

Depending on whether this is a short term or long term loss, the following happens (taken from [1])

Short-term losses counterbalance those expensive short-term gains. What's left at the end of Part I of Form 8949 is the net short-term capital gain or loss. If there were no gains, then obviously the net would equal the total loss. Long-term losses are applied to long-term gains. The result, at the end of Part II of Form 8949, is the net long-term capital gain or loss. Again, if you only have a loss, then the net is a negative number. Next, you combine the short-term and long-term results on Schedule D. At this point, a loss in one section can offset a gain in the other section. For example, if you have a net short-term loss of $1,000 and a net long-term gain of $1,200, then you'll pay tax on only $200. If there's still a loss, you can deduct up to $3,000 from other income. If you had a really bad year and ended up with a net loss of more than $3,000, you can carry forward the leftover portion to next year's taxes. The unused loss can be applied to next year's gains, as well as up to $3,000 of earned income. A big loss can be used as a deduction indefinitely -- another important reason to keep good records.

[1] http://www.bankrate.com/finance/taxes/capital-losses-can-hel...

Ok so you can deduct as much as you want from any 'capital gains' you might have but only are allowed to deduct a max of $3000 per year from regular income, and the leftover capital loss just keeps on rolling over perpetually until you die?

Also the other thing that's screwed up about this is you pay taxes when you exercise the options at the normal income tax rate. But when you want to apply the tax deduction in the event of a loss, you're only allowed to do it on 'capital gains' for an unlimited amount and a max of $3000 on normal income. In fact it might be preferable to deduct it against normal income and keep rolling it over and just pay normal capital gains taxes (which is much lower than your income tax rate typically).

> and the leftover capital loss just keeps on rolling over perpetually until you die?

Pretty much. I have a $10K capital loss from a bad investment over 10 years ago. I simply keep rolling it forward until I have a capital gain to offset it.

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