This gives you the maximum investment in company stock, providing you with potential for gains from increases in stock value and payment of dividends if any. Many employers now offer stock options in place of other popular benefits as a part of their employee incentive packages. Another good strategy is to exercise incentive options early in the year. Refer to Publication , Taxable and Nontaxable Income , for assistance in determining whether you've been granted a statutory or a nonstatutory stock option. He is still subject to the AMT and has to pay ordinary income tax on the spread as well. You currently own, or hold options on, too many shares of company stock than is healthy for your overall investment portfolio. Get Your Tax Record.
The most important variables to consider when deciding when to exercise your stock option are taxes and the amount of money you are willing to put at risk. There are three kinds of taxes you should consider when you exercise your Incentive Stock Options (the most common form of employee options.
What Does It Mean to Exercise a Stock Option?
The AMT amount, however, becomes a potential tax credit that you can subtract from a future tax bill. If in a subsequent year your regular tax exceeds your AMT, then you can apply the credit against the difference.
How much you can claim depends on how much extra you paid by paying the AMT in a prior year. That provides a credit that can be used in future years. The amount you would claim would be the difference between the regular tax amount and the AMT calculation.
If the regular amount is greater, you can claim that as a credit, and carry forward any unused credits for future years. This explanation is, of course, the simplified version of a potentially complex matter.
Anyone potentially subject to the AMT should use a tax advisor to make sure everything is done appropriately. One way to deal with the AMT trap would be for the employee to sell some of the shares right away to generate enough cash to buy the options in the first place. So an employee would buy and sell enough shares to cover the purchase price, plus any taxes that would be due, then keeps the remaining shares as ISOs. For instance, an employee might buy 5, shares on which he or she has options and keep 5, But the employee will have more than enough cash left over to deal with this.
Another good strategy is to exercise incentive options early in the year. That's because the employee can avoid the AMT if shares are sold prior to the end of the calendar year in which the options are exercised. John holds on to the shares, but watches the price closely.
John is a higher-income taxpayer. If, however, John sells before December 31, he can protect his gains. The rule here is that is the sale price is less than the fair market value at exercise but more than the grant price, then ordinary income tax is due on the spread. On the other hand, if in December the stock price still looks strong, John can hold on for another month and qualify for capital gains treatment.
By exercising early in the year, he has minimized the period after December 31 he must hold the shares before making a decision to sell. The later in the year he exercises, the greater the risk that in the following tax year the price of the stock will fall precipitously.
If John waits until after December 31 to sell his shares, but sells them before a one-year holding period is up, then things are really bleak. He is still subject to the AMT and has to pay ordinary income tax on the spread as well.
Skip to Main Content. Choices When Exercising Stock Options Usually, you have several choices when you exercise your vested stock options: Hold Your Stock Options Initiate an Exercise-and-Hold Transaction cash for stock Initiate an Exercise-and-Sell-to-Cover Transaction Initiate an Exercise-and-Sell Transaction cashless Hold Your Stock Options If you believe the stock price will rise over time, you can take advantage of the long-term nature of the option and wait to exercise them until the market price of the issuer stock exceeds your grant price and you feel that you are ready to exercise your stock options.
The advantages of this approach are: Top Initiate an Exercise-and-Hold Transaction cash-for-stock Exercise your stock options to buy shares of your company stock and then hold the stock.
Top Initiate an Exercise-and-Sell-to-Cover Transaction Exercise your stock options to buy shares of your company stock, then sell just enough of the company shares at the same time to cover the stock option cost, taxes, and brokerage commissions and fees.
Top Initiate an Exercise-and-Sell Transaction cashless With this transaction, which is only available from Fidelity if your stock option plan is managed by Fidelity, you may exercise your stock option to buy your company stock and sell the acquired shares at the same time without using your own cash. When you sell shares which were received through a stock option transaction you must: View and Exercise Your Stock Options If you have stock options in a plan that is administered by Fidelity, you can view, model or exercise options online.
You will also likely pay brokerage commissions, fees and taxes. You purchase your option shares and then and immediately sell them. In many cases, your brokerage will allow this transaction without using your own cash, with the proceeds from the stock sale covering the purchase price, as well as the commissions, fees and taxes associated with the transaction. This choice provides you with cash in your pocket to put into other investments or use as you otherwise see fit.
You exercise the option and then immediately sell just enough shares to cover the purchase price, commissions, fees and taxes. Your resulting proceeds will remain in the form of company stock. A stock swap is another form of cashless stock option exercise. With a stock swap, you exchange company shares that you already own to pay for the shares obtained through the exercise of your stock option. The main benefit to this choice is avoidance of taxes.
Keep in mind, however, that you must hold the shares used in the exchange for a stated period of time typically one or two years in order to avoid the transaction being treated as a sale and incurring tax costs.
Tax implications will play a key in role in your decisions on when and how to exercise your stock options. Remember, poor choices can have a devastating effect on your financial well being. Always consider consulting with a tax expert before exercising any stock option. The IRS recognizes two types of stock options: Options granted through an employee stock purchase plan or incentive stock option ISO plan are considered statutory stock options.
Tax Considerations for Incentive Stock Options. There are three main forms of taxes that must be considered when exercising an ISO: When you exercise your options and purchase your shares at a fair market value higher than the grant price, but do not immediately sell your shares, you will likely be required to pay a federal AMT, and possibly a state AMT.
In regard to long-term capital gains taxes, consider that you will pay a more favorable long-term capital gains tax rate if you exercise your options, hold the shares for more than a year, and then sell your shares more than two years after the option grant date.
You then hold these shares for at least one year before selling them and pay taxes at the combined federal and state marginal long-term capital gains tax rate of The AMT will be credited against the taxes you owe when you sell your exercised stock earlier.
Alternatively, if you believe that your company's stock will appreciate rapidly, it may be worth exercising your stock options early and paying the higher tax rates. The result may be to accumulate a great deal of wealth from owning a larger piece of a profitable company.
There are many examples of employees at startups, like Instagram, who became millionaires overnight from their stock options alone. Financial decisions can be extremely complicated, even for the most experienced investor. Make sure that you understand all of the legal and tax implications involved before before exercising your stock options. You can begin the process by discussing your situation directly with the legal professionals on UpCounsel's marketplace.
Exercising stock options can be complicated and result in significant financial consequences. Here are some of the various strategies and tactics to consider.7 min read Many employers now offer stock options in place of other popular benefits as a part of their employee incentive packages. Stock. Incentive stock options enjoy favorable tax treatment compared to other forms of employee compensation. Learn about ISO and what the tax obligation is. the gross amount received from selling the stock; Selling date: the date on which the stock was sold. Tax treatment of exercising incentive stock options. Welcome to the Wealthfront Knowledge Center Unless you sell stock at the time of exercise to cover your withholding, you will have to write a check to your employer for the taxes withheld. If you have incentive stock options (ISOs), your employer will not withhold taxes. That means it’s up to you to self-regulate and set aside the taxes.