The two types of taxation to keep in mind when exercising your options are ordinary income tax and capital gains tax. We detailed the tax benefits of having ISOs.
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It is important to note that the election must be made no later than 30 days after the property transfer, and if the stock received is later forfeited, no deduction or refund of tax previously paid is allowed. Careful analysis and research should be done before making the election. A unique opportunity associated with NQSOs is the ability to gift the options. Unlike Sec. Additionally, Sec. The bargain element income from the exercise will be recognized by the individual who performed the services to earn the options.
How to Report Stock Options on Your Tax Return - TurboTax Tax Tips & Videos
The donee will not be subject to income tax on this amount. The tax paid is not a taxable gift to the donee, as it is a personal liability of the donor. The issuing company's plan must allow for gifting of such options. ISOs are similar to NQSOs in that they represent a right to purchase shares at a specific price within a certain period.
For the option holder to reap these benefits, the options must qualify as ISOs under Sec. The following list illustrates some of the requirements that must be met for an option to be an ISO:. This list is not all - inclusive , but it provides a general idea of the types of rules that must be complied with for an option to qualify as an ISO. Qualifying disposition: If options that meet the requirements to be ISOs are disposed of in a qualifying disposition, the owner of the ISOs will receive the following tax treatment upon exercise of the options and the subsequent sale of the stock:.
Disqualifying disposition: If the ISO stock is disposed of in a disqualifying disposition i. Thus, the income attributable to the exercise of the option the FMV of the stock at the time it is substantially vested less the exercise price is treated by the option holder as ordinary compensation income for regular tax purposes in the tax year the disqualifying disposition occurs. However, if the disqualifying disposition of the stock is a sale or exchange for a price less than the price of the stock at exercise, the amount that is includible as compensation attributable to the exercise of the option is limited to the excess if any of the amount realized on the sale or exchange over the adjusted basis of the stock.
If the disqualifying disposition occurs in the same year as the exercise, the tax treatment is similar to that for an NQSO, with the bargain element in the stock at the time of exercise being ordinary income for the option holder in the year of exercise for both regular tax and AMT purposes, so that no AMT adjustment is necessary in that year. If the stock is disposed of in a disqualifying disposition for an amount greater than the FMV of the stock at exercise, the character of the amount of gain is determined under the Sec. AMT considerations and planning opportunities. Between the limitation and removal of typical itemized deductions that have caused taxpayers to be subject to the AMT, plus an increase in the AMT exemption amount, an environment has been created where many individuals who have historically been subject to the AMT will no longer find themselves in that situation.
Individuals with high ordinary income, such as wages, could be even further immunized from the AMT regime.
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On the surface, a taxpayer's being subject to the AMT in the year of exercise seemingly thwarts the strategy behind owning ISOs. This situation somewhat hinders the option holder's enjoyment of the coveted ISO benefits. It is important to remember that all is not necessarily lost if clients find themselves subject to the AMT during the year of exercise due to the AMT credit, which is explored further below.
The following are some planning options associated with ISOs:. Exercising and immediately selling will trigger a disqualifying disposition. Similar to the strategy discussed in the NQSO section, this strategy may appeal to those clients looking to limit their cash outlay or exposure to a concentrated position in company stock. The options are exercised and the shares are sold more than two years after the grant date and more than one year after exercise.
The tax results of a qualifying disposition are described above.
As noted, in this scenario, appreciation in the value of the stock above the exercise price will be taxed at long - term capital gains rates. Intentional disqualifyingdisposition. Prior to the dot - com bubble of the late s, many individuals in the tech industry exercised highly valued ISOs, incurring a large AMT liability on top of the price paid to exercise options. After the market crash and subsequent rapid devaluation of their position, some were left holding stock worth significantly less than the price they paid to acquire it and were unable to pay the AMT incurred due to the exercise of the ISOs.
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A method to potentially avoid a disaster like this would be to exercise early in the year, or some other time that is deemed advantageous, and track the stock value throughout the year. If the value greatly depreciates, the stock can be sold before year end. This would intentionally trigger a disqualifying disposition, thus avoiding the positive AMT adjustment and any accompanying AMT tax liability. This is a mix of the exercise - and - sell and the exercise - and - hold strategies.
Like the strategy discussed in the NQSO planning section, this can be used to improve cash flow during the exercise event. The immediate sale of the shares to cover the AMT is a disqualifying disposition.
Don't overlook the risk that comes with your employee stock options
The remaining shares received can be held for future appreciation and, if the holding period requirements are met, favorable qualifying disposition treatment. If an individual already owns shares of company stock and wants to limit the cash outlay on the exercise of ISOs, a swap could be of value. The existing shares will be exchanged with the issuing company for the new ISO shares. It is important to note that the swap itself is tax - free , but not necessarily the exercise, as this could generate an AMT liability.
Consideration should be given for special situations, such as if the shares being swapped in are ISO shares themselves. The company's stock plan must allow for swapping.
Although the plans are similar, they are not the same. Both kinds of plans can be either qualified for special tax treatment or unqualified. Both can be offered to an exclusive group of participants as in the case of non-qualified Employee Stock Purchase Plans, or to all full-time employees under qualified plans. A stock option gives you the right to purchase the underlying shares represented by the option for a future period of time at a pre-established price.
Stock options do expire. The expiration period varies from plan to plan. Once your options expire, they are worthless. There are often special rules for terminated, retired, and deceased employees. These life events may accelerate the expiration. Check your plan rules for details about expiration dates. There are usually special rules in the event you leave your employer, retire, or die.
See your employer's plan rules for details. See Accepting and Declining Grants for details. The Summary page for stock option plans displays information about grant totals, unaccepted grants, and accepted grants. From this page, you can view detailed information about a particular grant, accept or decline unaccepted grants, exercise accepted grants, or estimate the gain on a particular grant.
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New Ventures. Search Search:. Feb 15, at AM. Author Bio Charlene Rhinehart is a personal finance writer and former financial analyst. Her goal is to help more individuals build a stock portfolio that's bigger than their shoe collection. With a background in taxes and pageantry, Charlene is always ready to sprinkle a bit of glam and happiness into her work to help individuals achieve their goals. Image source: Getty Images. Stock Advisor launched in February of Join Stock Advisor. Next Article. Prev 1 Next.