By: Tony Wimperis, CPA
Employer stock options are an excellent reward for hard work and loyal service. A significant benefit to employees is that they can purchase their company’s stock at a discount from the stock’s current market price – and the proceeds from the sales are often substantial! Many large employers offer them, but these options often have unforeseen tax implications that should be addressed and planned for.
There are different types of employer stock options, and the tax rules in this area are very complex. Generally, they fall into two basic types for tax treatment: NSOs and ISOs. There are no tax implications when either option is granted to you –the issues arise when exercised.
NSOs (Non-Qualified Options) – When exercised, the employee must report the value of the stock received from the options as income on their tax return. Their payroll department usually treats this value as additional wages and is reported on their W-2 for the year. If this is the case, it is crucial to address Federal and state income tax withholdings with your payroll department. If left unaddressed, this often results in little or no extra withholding, creating a very large tax bill when you file your tax returns.
The employee can continue to hold the stock indefinitely. When the stock is sold, the employee has a capital gain equal to the sale’s proceeds; less the amount previously included in their W-2 earnings. In this situation, a Form 1099-B is issued reporting the sale details, which you must remember to provide to your accountants at year-end.
ISOs (Incentive Stock Options) – These options come with more ‘strings attached’ but generally provide more favorable tax treatment. There is no income to report on your tax return in the year the options are exercised – just when the stock is ultimately sold. The stock sale will qualify for lower long-term capital rates if held longer than one year. However, the difference between the fair market value received and the option’s exercise price is reported as an add back for alternative minimum tax purposes on your tax return in Year 1, which could result in additional upfront taxes. Since the payroll department will not include it in the employee’s wages, discussing these implications with your tax advisor is essential.
To gain this favorable tax treatment, there are time frames and other stipulations that must generally be met with ISOs– the first major one is that the options must be held at least two years from the grant date, but not longer than ten years, among other restrictions.
As you can see, this area is complex and often requires tax planning to ensure the tax bases are covered. Are you planning on exercising stock options in 2022? Don’t hesitate to get in touch with a R+R tax advisor today!
Reynolds + Rowella is a regional accounting and consulting firm known for a team approach to financial problem solving. As Certified Public Accountants, our partners foster a personal touch with our clients. As members of DFK International/USA, an association of accountants and advisors, our professional network is international, yet many of our clients have known us for years through the local communities we serve.
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