The cost basis is the price paid to exercise the option plus the bargain element that was taxed as ordinary income in the exercise year. There are two types of stock options:. Standard mileage and other information. On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement. What to Know ". Video of the Day.
For individual investors out there dabbling in publicly traded stock options for the first time, you need to know how these securities get taxed. For the uninitiated, lets start with some definitions.
Grant Date, Expiration, Vesting and Exercise
Conceptually, options are an attractive payment method. In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options. As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax.
Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands. What's an Employee Stock Option? Grant Date, Expiration, Vesting and Exercise To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date. Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.
For non-qualified stock options NSO: The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately or less than a year from exercise , the transaction will be reported as a short-term capital gain or loss and will be subject to tax at ordinary income tax rates.
If the employee decides to sell the shares a year after the exercise, the sale will be reported as a long-term capital gain or loss and the tax will be reduced. Incentive stock options ISO receive special tax treatment: The grant is not a taxable transaction. You have taxable income or deductible loss when you sell the stock you received by exercising the option.
For specific information and reporting requirements, refer to Publication For you and your family. Individuals abroad and more. EINs and other information. Get Your Tax Record. Bank Account Direct Pay. Debit or Credit Card. Payment Plan Installment Agreement. Standard mileage and other information. Instructions for Form Request for Transcript of Tax Return. Employee's Withholding Allowance Certificate.
Employer's Quarterly Federal Tax Return. Employers engaged in a trade or business who pay compensation. Stock sold more than one year after exercising ISOs is taxed as long-term capital gain. Stock sold in one year or less after exercise, is taxed as short-term capital gain. However, if the sale proceeds are less than market value of the stock at exercise, only the actual gain is taxed as ordinary income.
There is no capital gain. When stock acquired from the exercise of ISOs is sold in the calendar year after exercising the options, another AMT adjustment is made. This AMT adjustment is made in the year of the sale because an adjustment was made in the earlier year of exercise. A qualified sale of stock acquired from exercising ISOs occurs more than one year after exercise and more than two years after the options were granted.
In this case, the bargain element is not taxed as ordinary income. The difference between sale proceeds and exercise price is taxed as long-term capital gain. The cost basis is only the exercise price. This adjustment accounts for the stock having a different cost basis under AMT than under the regular income tax method. This is a consequence of the adjustment made under AMT in the exercise year. Brian Huber has been a writer since , primarily composing literature for businesses that convey information to customers, shareholders and lenders.
Huber has written about various financial, accounting and tax matters and his published articles have appeared on various websites.
What's an Employee Stock Option?
The taxation of stock option contracts depends on the type of option owned. For non-qualified stock options (NSO): The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is . Jan 31, · For nonstatutory options without a readily determinable fair market value, there's no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. The tax on selling stock acquired from prior exercise of regular options depends upon how long the stock was held. Stock sold one year or less from the exercise date is taxed as a short-term capital gain. Stock sold more than one year after the date acquired is taxed as a long-term capital gain.