Stock options have become increasingly popular as a way of compensating or providing added benefits to employees. Stock options give the employee the right to buy a set number of shares of their company stock at a set price at a certain period in time. Our clients have many income tax questions about Nonqualified (Nonstatutory) Stock Options and Incentive Stock Options.
Nonqualified Stock Options (NQSO)
Non-Qualified Stock Options are granted or awarded to an employee giving him the right to purchase company stock at a specific price over a stated option term. When NQSOs are exercised, the employee will recognize ordinary income (on their W-2) equal to the difference between the market value of the company stock on the date of exercise and the grant price. Since NQSOs are considered ordinary income and reported as compensation on the employee’s W-2, they are subject to applicable federal and state income taxes. The taxes are withheld at the time of exercise. The basis of the stock when you sell it is now the market value on the exercise date—not your exercise price.
Incentive Stock Options (ISO)
Incentive Stock Options give an employee the right to purchase company stock at a specific exercise price over a stated option term. The holding requirement for an ISO is the later date of two years from the grant date or one year from the exercise date. If the holding period is violated, the ISO becomes nonqualified and is recognized as ordinary income. An ISO may provide a more favorable tax treatment than NQSOs if the exercised shares are held for at least one year, so that the sale qualifies for long-term capital gains treatment.
The ISO does not give rise to ordinary income, and there are no withholding requirements. Income tax is not withheld at the time of exercise. The basis for an ISO is the purchase price at the date of exercise. An employee who exercises ISOs may be subject to Alternative Minimum Tax. Alternative Minimum Taxable income is reported on the employee’s tax return for the difference between the market value of the stock on the date of exercise and the purchase price. This income is only reported on the Alternative Minimum Tax form along with other preference items and how Alternative Minimum Tax is calculated (26% for AMT income less than $175,000 and 28% for AMT income more than $175,000). The employee must pay whichever is higher, Alternative Minimum Tax or regular tax. A credit may be taken in future years for Alternative Minimum Tax paid in the year of exercise.
Contact your tax adviser when stock options are exercised. There are no tax consequences when the options are granted, but planning is essential and timing is critical to minimize the tax liability incurred when options are exercised. If you would like any further information regarding this issue as well as any other tax related issue, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
