Idea: the tax code should simply tax startup equity as normal income, at the time of sale, as much as possible. Tax the difference between value at grant time and value at the time of liquidity as ordinary income. Then tax the difference between that price and actual sale price as capital gains, to avoid penalizing employees from holding liquid stock.
Equity in a startup is effectively deferred cash compensation, in practice. It would be good to eliminate the complexities of option valuation, exercise concerns, and taxation issues from the list of worries of regular employees.
When does the clock for long-term capital gains start?
Better solution: the US tax code should eliminate the short-term/long-term capital gains distinction and just copy the model used in Canada (and elsewhere, I'm sure): capital gains are taxed as ordinary income at a rate of 50¢ on the dollar. So $2 capital gain is equivalent to $1 of ordinary income. The usual rules apply for day traders and such where their "capital gains" are active rather than passive income. The rate doesn't have to be 50 cents - it can be 40 or 60.
I'd start the clock either at grant time or vest time. After all, that part of your comp is locked up and you're investing your sweat equity in the company.
Equity in a startup is effectively deferred cash compensation, in practice. It would be good to eliminate the complexities of option valuation, exercise concerns, and taxation issues from the list of worries of regular employees.