How are employee stock options taxed?

Employee stock options are a great incentive that can be built into many compensation programs. Often, employees are able to buy the company’s shares at a discount, providing a great opportunity to accumulate wealth if the shares behave well.

But the other piece of the puzzle is trying to understand how taxes on employee stock options work. It could easily turn into a nightmare if you’ve never dealt with stock options before. Here are some ideas for clearing up the confusion so you can maximize the potential of this incredible benefit at work.

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How stock options work

There are two main types of stock options you might receive as part of your compensation giveaway: incentive stock options and non-qualified stock options. The main difference between the two is the way they are treated for tax purposes when you exercise the options.

Incentive stock purchase options (ISO), also called statutory stock purchase options, are granted as part of a stock purchase plan. However, unqualified stock options (NSOs) are granted without a specific plan type and are often referred to as non-statutory stock options. As we will see below, NSOs do not enjoy the same tax advantages as ISOs.

When you have employee stock options, there are three special occasions you should be aware of: when your company granted the options to you, when you exercised them, and for how long. you own the shares you receive on exercise before you sell them. These times play an important role in your tax calculation.

Most of the time, there is a vesting schedule tied to your employees’ stock options. Simply put, you cannot enjoy your stock option benefits until you have worked in your business for a while. Once the rights have been acquired, you can exercise the options at any time before they expire.

Incentive stock options

Incentive stock options are simpler than tax-unqualified stock options. Employees with ISOs do not have to worry about taxes when they receive a stock option grant or exercise the options.

The trade order works like this: you receive a stock option grant, and then exercise the options when you are eligible and ready to do so. After exercising your options, you will then have to make the final decision: when should I sell my shares?

Let’s say you received 2,000 shares at an exercise price of $ 10. On the date you decide to exercise your shares, the share is actually worth $ 30 per share. If you sell immediately, you’re paying $ 20,000 for something worth $ 60,000, but you’ll have to pay regular tax rates to lock in those gains now.

Your other option: exercise your options in one period and sell your shares later. You may be able to unlock long-term benefits capital gains tax rate (a maximum rate of 20%) if you hold ISOs for at least two years from the date of granting the options and more than one year from the date of exercise before selling; otherwise, you forfeit the right to exclusive tax benefits and risk ending up with ordinary income taxes it could reach 37%.

Double taxation of unqualified stock options

It is important to have a tax strategy when exercising NSOs as you will be taxed twice, and it can get a little complicated.

First, you will generally have to pay regular income taxes when you exercise the options. You have to pay the difference between what you paid for the shares (the strike price) and the fair value of the shares when you exercised them. The IRS considers this to be compensation income even if you haven’t actually made any money.

Then you will pay the capital gains tax if you sell the shares at a profit. If the sale results in a loss, you will report a capital loss equal to the difference between your tax base and what you received. You will pay short-term or long-term capital gains taxes depending on how long you hold the stock. When you hold your investment for more than a year, you are eligible for the preferential long-term capital gains rates of 0%, 15% or 20%, depending on your income bracket for the year.

No more taxes to consider

Although ISOs are generally considered a tax saver compared to NSOs, you will need to consider the alternative minimum tax (AMT) if you have a high income. There is also a limit of $ 100,000 which restricts the total value of ISOs that can be exercised in any given year if you want to take advantage of the incredible tax benefits.

The taxes on employee stock options can be overwhelming. If you have no idea what you are doing when you declare your taxes, search for a professional to make the process less draining.


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