You haven't received any cash; in fact, you paid cash to exercise the option, but you still have to come up with additional cash to pay the IRS. More Tax Topic Categories. This means the tax basis when you exercise the option consists of the exercise price, the premium you paid and any transaction costs. It's important to keep track of your basis in stock because this determines how much gain or loss you report when you sell the stock. There are two broad classifications of stock options issued: Popular For Tax Pros. First, NSOs are offered to non-executive employees and outside directors or consultants.
Qualified vs. Non-qualified Stock Options Diffen › Finance › Personal Finance › Taxation Depending upon the tax treatment of stock options, they can be classified as either qualified stock options or non-qualified stock options.
Options Tax Rates
For this reason, these plans have long served as a successful tool to attract top executives. Unfortunately, some still fail to take full advantage of the money generated by their employee stock.
Understanding the nature of stock options , taxation and the impact on personal income is key to maximizing such a potentially lucrative perk. There are two broad classifications of stock options issued: Non-qualified stock options differ from incentive stock options in two ways.
First, NSOs are offered to non-executive employees and outside directors or consultants. By contrast, ISOs are strictly reserved for employees more specifically, executives of the company. Secondly, nonqualified options do not receive special federal tax treatment, while incentive stock options are given favorable tax treatment because they meet specific statutory rules described by the Internal Revenue Code more on this favorable tax treatment is provided below.
Transactions within these plans must follow specific terms set forth by the employer agreement and the Internal Revenue Code. 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.
They must comply with a specific schedule known as the vesting schedule when exercising their options. The vesting schedule begins on the day the options are granted and lists the dates that an employee is able to exercise a specific number of shares. For example, an employer may grant 1, shares on the grant date, but a year from that date, shares will vest, which means the employee is given the right to exercise of the 1, shares initially granted.
The year after, another shares are vested, and so on. The vesting schedule is followed by an expiration date. On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement. An employee stock option is granted at a specific price, known as the exercise price. It is the price per share that an employee must pay to exercise his or her options.
Because the shares are normally sold quickly, you usually have a short-term capital gain. Your profit will therefore be taxed at the same rate as ordinary income. Should you choose to hold the shares for more than a year after purchasing them, this becomes a long-term capital gain, and is subject to a tax rate of 15 percent. The important thing to remember is that the length of time you own the shares determines which tax rates apply, not how long you held the options prior to being exercised.
When you exercise non-qualified employee stock options, your profit at the time of exercise is considered compensation instead of a capital gain, and is listed as such on your W-2 form. You pay taxes at the rates applicable to wages. If you choose to hold the shares instead of selling them immediately, any further appreciation of the stock is a capital gain. If you own the stock for more than a year, you have a long-term capital gain.
Otherwise, it is a short-term gain. Companies sometimes award incentive stock options ISOs to valued employees. An ISO has a tax advantage provided you meet certain conditions. All of the profit from the exercise and eventual sale of the options becomes a long-term capital gain. 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.
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.
Grant Date, Expiration, Vesting and Exercise
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. The compensation element is already included in Boxes 1, 3 (if applicable) and 5, but is also reported separately in Box 12 to clearly indicate the amount of compensation arising from an non-qualified stock option exercise. TurboTax Premier Edition offers extra help with investments and can help you get the best results under the tax law. What tax rate you pay when you exercise stock options depends on what kind of options you receive. Incentive stock options vs. nonqualified stock options There are two types of employee stock options. If your employer follows certain rules, then you can receive incentive stock options, which have favorable tax characteristics.