How Stock Options Are Taxed & Reported

Inventory choices are worker advantages that allow them to purchase the employer’s inventory at a reduction to the inventory’s market worth. The choices don’t convey an possession curiosity, however exercising them to amass the inventory does. There are various kinds of choices, every with its personal tax outcomes.

Two Varieties of Inventory Choices

Inventory choices fall into two classes: 

Tax Guidelines for Statutory Inventory Choices

The grant of an ISO or different statutory inventory possibility doesn’t produce any speedy earnings topic to common earnings taxes. Equally, the train of the choice to acquire the inventory doesn’t produce any speedy earnings so long as you maintain the inventory within the 12 months you purchase it. Earnings outcomes if you later promote the inventory acquired by exercising the choice.

Nonetheless, exercising an ISO produces an adjustment for functions of the choice minimal tax, or AMT—a shadow tax system designed to make sure that those that scale back their common tax by way of deductions and different tax breaks pays at the very least some tax. The adjustment is the distinction between the truthful market worth of the inventory acquired by way of the train of the ISO over the quantity paid for the inventory, plus the quantity paid for the ISO if any.

Nonetheless, the adjustment is required provided that your rights within the inventory are transferable and never topic to a considerable threat of forfeiture within the 12 months the ISO is exercised. And the truthful market worth of the inventory for functions of the adjustment is set with out regard to any lapse restriction when rights within the inventory first develop into transferable or when the rights are now not topic to a considerable threat of forfeiture.

When you promote the inventory in the identical 12 months you exercised the ISO, no AMT adjustment is required. It is because the tax therapy turns into the identical for normal tax and AMT functions.

If you need to make an AMT adjustment, enhance the premise within the inventory by the AMT adjustment. Doing this ensures when the inventory is offered sooner or later, the taxable achieve for AMT functions is proscribed, which implies you don’t pay tax twice on the identical quantity.

How Reporting Works

Whenever you train an ISO, your employer points Type 3921—Train of an Incentive Inventory Possibility Plan beneath Part 422(b), which offers the data wanted for tax-reporting functions.

Right here’s an instance of the way to use the data from Type 3921 to report the train of an ISO:

For instance, this 12 months you exercised an ISO to amass 100 shares of inventory, the rights of which grew to become instantly transferable and never topic to a considerable threat of forfeiture. You paid $10 per share (the train worth), which is reported in field 3 of Type 3921. On the date of train, the truthful market worth of the inventory was $25 per share, which is reported in field 4 of the shape. The variety of shares acquired is listed in field 5. The AMT adjustment is $1,500 ($2,500 [box 4 multiplied by box 5] minus $1,000 [box 3 multiplied by box 5]).

Whenever you promote the inventory acquired by way of the train of an ISO or an worker inventory buy plan, you report a achieve or loss on the sale. When the inventory was acquired at a reduction beneath an worker inventory possibility plan, you’ll obtain Type 3922—Switch of Inventory Acquired By an Worker Inventory Buy Plan out of your employer or the company’s switch agent. The data on this way helps you establish the quantity of achieve or loss, and whether or not it’s capital or abnormal earnings.

Tax Guidelines for Nonstatutory Inventory Choices

For such a inventory possibility, there are three occasions, every with its personal tax outcomes: The grant of the choice, the train of the choice, and the sale of inventory acquired by way of the train of the choice. The receipt of those choices is straight away taxable provided that their truthful market worth could be readily decided (e.g., the choice is actively traded on an trade). Most often, nevertheless, there isn’t a readily ascertainable worth, so the granting of the choices doesn’t lead to any tax.

Whenever you train the choice, you embody, in earnings, the truthful market worth of the inventory on the time you acquired it, much less any quantity you paid for the inventory. That is abnormal wage earnings reported in your W2, subsequently rising your tax foundation within the inventory.

Later, if you promote the inventory acquired by way of the train of the choices, you report a capital achieve or loss for the distinction between your tax foundation and what you obtain on the sale.

The Backside Line

Inventory choices generally is a helpful worker profit; nevertheless, the tax guidelines are complicated. When you obtain inventory choices, it’s best to discuss to a tax advisor to find out how these tax guidelines have an effect on you.