Tax rules for employee stock options

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When you exercise non-qualified stock options, the difference between the market price of the stock and the grant or exercise price called the spread is counted as ordinary earned income, even if you exercise your options and continue to hold the stock. Earned income is subject to payroll taxes Social Security and Medicare , as well as regular income taxes at your applicable tax rate. You pay two types of payroll taxes:.

If your earned income for the year already exceeds your benefit base, then your payroll taxes on gain from exercising your non-qualified stock options will be just the 1. If your year-to-date earned income is not already in excess of the benefit base than when you exercise non-qualified stock options, you will pay a total of 7.

Taxation of employee stock options

You should not exercise employee stock options strictly based on tax decisions. In addition to the payroll taxes, all income from the spread is subject to ordinary income taxes. If you hold the stock after exercise, and additional gains beyond the spread are achieved, the additional gains are taxed as a capital gain or as a capital loss if the stock went down.

Unlike non-qualified stock options, gain on incentive stock options is not subject to payroll taxes. However it is, of course, subject to tax, and it is a preference item for the AMT alternative minimum tax calculation. When you exercise an incentive stock option there are a few different tax possibilities:. You exercise the incentive stock options and sell the stock within the same calendar year: In this case, you pay tax on the difference between the market price at sale and the grant price at your ordinary income tax rate.

You can get a credit for excess AMT tax paid, but it may take many years to use up this credit. If you hold the shares for one year from your exercise date two years from the grant date of the option then the difference between grant price and market price when you sell the options is taxed as long-term gain rather than ordinary income, and if your ordinary tax rate exceeds your AMT tax rate you may get to use some of the previously accumulated AMT credit. Tax rules can be complex. National Center for Employee Ownership.

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List of Partners vendors. The options do not convey an ownership interest, but exercising them to acquire the stock does. There are different types of options, each with their own tax results. Stock options fall into two categories:. The grant of an ISO or other statutory stock option does not produce any immediate income subject to regular income taxes. Similarly, the exercise of the option to obtain the stock does not produce any immediate income as long as you hold the stock in the year you acquire it.

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Income results when you later sell the stock acquired by exercising the option. The adjustment is the difference between the fair market value of the stock acquired through the exercise of the ISO over the amount paid for the stock, plus the amount paid for the ISO if any.

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However, the adjustment is required only if your rights in the stock are transferable and not subject to a substantial risk of forfeiture in the year the ISO is exercised. And the fair market value of the stock for purposes of the adjustment is determined without regard to any lapse restriction when rights in the stock first become transferable or when the rights are no longer subject to a substantial risk of forfeiture. This is because the tax treatment becomes the same for regular tax and AMT purposes.

When you exercise an ISO, your employer issues Form —Exercise of an Incentive Stock Option Plan under Section b , which provides the information needed for tax-reporting purposes. For example, this year you exercised an ISO to acquire shares of stock, the rights of which became immediately transferable and not subject to a substantial risk of forfeiture. The number of shares acquired is listed in box 5. When you sell the stock acquired through the exercise of an ISO or an employee stock purchase plan, you report a gain or loss on the sale. The information on this form helps you determine the amount of gain or loss, and whether it is capital or ordinary income.

How are Stock Options Taxed?

For this type of stock option, there are three events, each with their own tax results: The grant of the option, the exercise of the option, and the sale of stock acquired through the exercise of the option. The receipt of these options is immediately taxable only if their fair market value can be readily determined e. When you exercise the option, you include, in income, the fair market value of the stock at the time you acquired it, less any amount you paid for the stock.

This is ordinary wage income reported on your W2, therefore increasing your tax basis in the stock. Later, when you sell the stock acquired through exercise of the options, you report a capital gain or loss for the difference between your tax basis and what you receive on the sale. Stock options can be a valuable employee benefit. However, the tax rules are complex.

Stock option planning: Generating value

If you receive stock options, you should talk to your tax advisor to determine how these tax rules affect you. Internal Revenue Service. Accessed Jan. Income Tax.