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. 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. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.
We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice.
Popular Courses. Personal Finance Taxes. Key Takeaways Stock options fall into two different categories: Statutory, granted under purchase plans or incentive stock options plans, and nonstatutory options that come with no plans.
14 Ways to Reduce Stock Option Taxes
Income results when you sell stocks acquired by exercising statutory stock options, which produces the alternative minimum tax. If you exercise the nonstatutory option, you must include the fair market value of the stock when you acquired it, less any amount you paid for the stock.
When you sell the stock, you report capital gains or losses for the difference between your tax basis and what you receive on the sale. Article Sources.
Reporting Sales of Nonqualified Option Stock
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation.
Related Articles. Partner Links.
An ISO is the right to purchase company stock according to a written plan designed to meet a number of requirements in section of the Internal Revenue Code Code. Your employer may or may not design the options granted to you to meet these requirements. If your employer does this, generally your option grant will specify that the options are ISOs. If the stock options are designed to meet all the ISO requirements, the following tax consequences should result:.
If the facts are the same as in Example 1, except that the employee sold the stock only 10 months after exercising the option, then the result is a disqualifying disposition. As mentioned above, the significance of holding an NSO instead of an ISO comes down to the tax consequences that apply. At the time of the grant, the options do not have a readily ascertainable FMV. In this case, the amount reported as ordinary income and capital gain is the same as in Example 2 for a disqualifying disposition, but there are some differences.
A disqualifying disposition results in ordinary income on the disposition date rather than the exercise date although those may sometimes be the same date , and the ordinary income from a disqualifying disposition is not subject to income and payroll tax withholding, but ordinary income from the exercise of an NSO is subject to income and payroll tax withholding.
An employee is generally taxed upon exercise of the option on the difference between the exercise price and the FMV on that date. The gain is treated as ordinary income, reportable as compensation. This result assumes the option does not have a readily available FMV. If the option has a readily available FMV, which is rare, employees are taxed upon grant rather than upon exercise. An employer must address how to handle the tax withholding obligations of NSOs as the exercise of a stock option results in a stock transfer instead of cash, yet taxes must be withheld.
Option plans may require that the employee pay the employer the cash amount needed to cover the income and payroll withholding tax obligations together with the exercise price. Alternatively, the employee and employer can agree that any required withholding taxes will be withheld from other wages payable to the employee, or agree to reduce the number of shares transferred upon the exercise by the value of the withholding obligation.
In some cases, the employer may be willing to gross up the benefit by agreeing to cover the withholding costs. However, in such instances, the gross up itself results in additional taxable wages. Note: This chart is a summary only. Please consult your tax advisor for specific tax consequences. An employee stock purchase plan ESPP grants employees options to purchase company stock at a slightly discounted price.
Generally, ESPPs are designed so that the employee pays no tax on the option until the disposition of the share purchased after the option is exercised. Similar to an ISO, any gain upon disposition is treated as a capital gain. Important aspects of ESPPs include not setting the option price too low, and specific holding-period requirements like an ISO disqualifying disposition.
The major difference between options granted under an ESPP as compared to ISOs is that ESPPs have nondiscrimination rules and are offered to a larger group of employees and may generally be tied in with the payroll process of your employer. Section 83 b allows employees to elect to defer income tax on property received in connection with the performance of services.
Fairmark Forum Login
Section 83 regulations provide a distinction between the direct acquisition of property by a person, and a person acquiring an option to purchase property. Generally, the grant of an option is not the transfer of the underlying property; thus, a section 83 b election does not apply.
Options can be very rewarding to holders, but they also can be complex to understand. You should consult with your tax advisor to better understand your specific options and how they interact with your overall tax and financial situation.
The member firms of RSM International collaborate to provide services to global clients, but are separate and distinct legal entities that cannot obligate each other. Each member firm is responsible only for its own acts and omissions, and not those of any other party. Visit rsmus.