How Stock Options Are Taxed and Reported (2024)

Stock options are employee benefits that enable them to buy the employer’s stock at a discount to the stock’s market price. The options do not convey an ownership interest, but exercising them to acquire the stock does. There are different types of options, each with its own tax results.

Key Takeaways

  • Stock options fall into two different categories: Statutory, granted under purchase plans or incentive stock options plans, and nonstatutory options that come with no plans.
  • Income results when you sell stocks acquired by exercising statutory stock options, which produces the alternative minimum tax.
  • If you exercise the nonstatutory option, you must include the fair market value of the stock when you acquired it, less any amount you paid for the stock.
  • When you sell the stock, you report capital gains or losses for the difference between your tax basis and what you receive on the sale.

2 Types of Stock Options

Stock options fall into two categories:

  • Statutory stock options, which are granted under an employee stock purchase plan or an incentive stock option (ISO) plan
  • Nonstatutory stock options, also known as non-qualified stock options, are granted without any type of plan

Tax Rules for Statutory Stock Options

The grant of an ISO or other statutory stock option does not produce any immediate income subject to regular income taxes. Similarly, the exercise of the option to obtain the stock does not produce any immediate income as long as you hold the stock in the year you acquire it. Income results when you later sell the stock acquired by exercising the option.

However, exercising an ISO produces an adjustment for purposes of the alternative minimum tax, or AMT—a shadow tax system designed to ensure that those who reduce their regular tax through deductions and other tax breaks will pay at least some tax. The adjustment is the difference between the fair market value of the stock acquired through the exercise of the ISO over the amount paid for the stock, plus the amount paid for the ISO if any.

However, the adjustment is required only if your rights in the stock are transferable and not subject to a substantial risk of forfeiture in the year the ISO is exercised. And the fair market value of the stock for purposes of the adjustment is determined without regard to any lapse restriction when rights in the stock first become transferable or when the rights are no longer subject to a substantial risk of forfeiture.

Form 6251 will help you figure out if you owe any AMT after you exercise an ISO.

If you sell the stock in the same year you exercised the ISO, no AMT adjustment is required. This is because the tax treatment becomes the same for regular tax and AMT purposes.

If you have to make an AMT adjustment, increase the stock's cost basis by the AMT adjustment. Doing this ensures when the stock is sold in the future, the taxable gain for AMT purposes is limited, which means you don’t pay tax twice on the same amount.

How Reporting Works

When you exercise an ISO, your employer issues Form 3921—Exercise of an Incentive Stock Option Plan under Section 422(b), which provides the information needed for tax-reporting purposes.

Here’s an example of how to use the information from Form 3921 to report the exercise of an ISO:

For example, this year you exercised an ISO to acquire 100 shares of stock, the rights of which became immediately transferable and not subject to a substantial risk of forfeiture. You paid $10 per share (the exercise price), which is reported in box 3 of Form 3921.

On the date of exercise, the fair market value of the stock was $25 per share, which is reported in box 4 of the form. The number of shares acquired is listed in box 5. The AMT adjustment is $1,500 ($2,500 [box 4 multiplied by box 5] minus $1,000 [box 3 multiplied by box 5]).

When you sell the stock acquired through the exercise of an ISO or an employee stock purchase plan, you report a gain or loss on the sale. When the stock was acquired at a discount under an employee stock option plan, you’ll receive Form 3922—Transfer of Stock Acquired Through an Employee Stock Purchase Plan from your employer or the corporation’s transfer agent. The information on this form helps you determine the amount of gain or loss, and whether it is capital or ordinary income.

Tax Rules for Nonstatutory Stock Options

For this type of stock option, there are three events, each with its own tax results: The grant of the option, the exercise of the option, and the sale of stock acquired through the exercise of the option.

The receipt of these options is immediately taxable only if their fair market value can be readily determined (e.g., the option is actively traded on an exchange). In most cases, however, there is no readily ascertainable value, so the granting of the options does not result in any tax.

When you exercise the option, you include, in income, the fair market value of the stock at the time you acquired it, less any amount you paid for the stock. This is ordinary wage income reported on your W2, therefore increasing your tax basis in the stock.

Later, when you sell the stock acquired through the exercise of the options, you report a capital gain or loss for the difference between your tax basis and what you receive on the sale.

How Does a Stock Option Work?

A stock option gives an employee the right to buy (not obligated to do so) a pre-determined number of shares of a company's stock at a pre-determined price. There is usually a vesting period before you are able to purchase the stock.

Is a Stock Option a Good Benefit?

Yes, a stock option can be a good benefit. If employees receive stock options, they have a personal interest in the company. If the company does well, its share price goes up, and the employees see a financial benefit. If the company is private, stock options can also be a good benefit if the company eventually goes public, bringing a financial gain to employees who have stock options.

How Are Stock Options Taxed?

Stock options are taxed or the loss is deducted when the holder of the stock sells the stock they bought when they exercised their stock option. The gain will usually be taxed at a capital gains tax rate.

The Bottom Line

Stock options can be a valuable employee benefit; however, the tax rules are complex. If you receive stock options, you should talk to a tax advisor to determine how these tax rules affect you.

How Stock Options Are Taxed and Reported (2024)

FAQs

How Stock Options Are Taxed and Reported? ›

Capital gains tax for stock options

How stock options are taxed and reported? ›

When you exercise the option, you include, in income, the fair market value of the stock at the time you acquired it, less any amount you paid for the stock. This is ordinary wage income reported on your W2, therefore increasing your tax basis in the stock.

How much tax will I pay for my stock options? ›

When you exercise nonqualified stock options, your employer will most likely withhold a flat 22% for federal income taxes. However, you might be under-withheld if you're in the 32%, 35%, or 37% tax bracket. Stock options can be advantageous but can also create unexpected tax consequences.

How are stock options reported on financial statements? ›

The use of employee stock options effectively involves two types of transactions: the payment of compensation in the form of employee stock options (reflected on the income statement) and, when the options are exercised, a financing transaction (reflected on the balance sheet).

How are stocks reported on taxes? ›

You must report all 1099-B transactions on Schedule D (Form 1040), Capital Gains and Losses and you may need to use Form 8949, Sales and Other Dispositions of Capital Assets. This is true even if there's no net capital gain subject to tax.

How do I avoid income tax on stock options? ›

TLDR
  1. Exercise early and File an 83(b) Election.
  2. Exercise and Hold for Long Term Capital Gains.
  3. Exercise Just Enough Options Each Year to Avoid AMT.
  4. Exercise ISOs In January to Maximize Your Float Before Paying AMT.
  5. Get Refund Credit for AMT Previously Paid on ISOs.
  6. Reduce the AMT on the ISOs by Exercising NSOs.

Where are stock options reported? ›

Equity Compensation Income Left Off W-2

What if your company does not report your employee stock compensation income on Form W-2? According to recent changes to Schedule 1 of Form 1040 and its instructions, the amount goes in the “Other Income” section on Line 8k (“Stock Options”).

Do you pay taxes twice on stock options? ›

Stock options are typically taxed at two points in time: first when they are exercised (purchased) and again when they're sold. You can unlock certain tax advantages by learning the differences between ISOs and NSOs.

How to calculate income tax on options trading? ›

If you are trading in Futures and Options, you should get your accounts audited if your turnover is more than ₹10 crore. You can also apply a presumptive taxation scheme if your turnover does not exceed ₹2 crore and declare that your taxable income is at 6% of the total Futures and Options turnover.

How to calculate gain on stock options? ›

This total price, for the purpose of this example, can be considered the original purchase price. To calculate your gain or loss, subtract the original purchase price from the sale price and divide the difference by the purchase price of the stock. Multiply that figure by 100 to get the percentage change.

How are employee stock options reported? ›

Form 3922. Form 3922 is issued for employee stock options you purchased but do not sell. Since you have not sold the stock, the holding period requirements have not been determined. Therefore, the employer does not include compensation income on your Form W-2 as ordinary income.

What is the accounting treatment for stock options? ›

When an employee exercises stock options, you'll credit Common Stock for the number of shares x par value, debit Cash for the number of shares x the exercise price, then debit Additional Paid-In Capital for the difference, representing the increase in value of the shares during the service period.

Do you have to declare stock options? ›

The security options benefit is taxable to you as employment income in the year you exercise the options. It's reported to you on your T4 tax slip, along with your salary, bonus and other sources of employment income.

Do stock options count as income? ›

You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.

What are the tax rules for options? ›

The IRS applies what is known as the 60/40 rule to all non-equity options, meaning that all gains and losses are treated as:
  • Long-Term: 60% of the trade is taxed as a long-term capital gain or loss.
  • Short-Term: 40% of the trade is taxed as a short-term capital gain or loss.
Jan 5, 2024

What happens if you don't report stocks on taxes? ›

If you fail to report the gain, the IRS will become immediately suspicious. While the IRS may simply identify and correct a small loss and ding you for the difference, a larger missing capital gain could set off the alarms.

Are you taxed twice on stock options? ›

Don't Pay Taxes Twice on Stock Options: Protect Yourself From the 'Double Tax Trap' Navigating the complex landscape of stock option taxation can be a daunting task, and unfortunately, many people find themselves paying income taxes twice, first as wage withholdings and then again as capital gains.

Do stock options count as income on W-2? ›

Non-statutory stock options

In the year the NSOs are granted or become vested, the employee includes nothing in income. However, in the year the NSOs are exercised, the spread (fair value less strike price) is included as W-2 income to the employee. This spread will be shown as a Box 12 Code V item on the W-2.

Are stock options taxed when they vest? ›

How are stock options taxed upon exercise? No Taxes! No Taxes! RSUs are taxed upon vesting unless they have a "double trigger" vesting schedule.

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