The Tax Implications of Stock Options

Tax Implications of Stock Options

Two Main Types

Non-Qualified Stock Options (NSOs)

• Available to employees, contractors, and directors
• Taxed when exercised as ordinary income on the spread (FMV - exercise price)
• Subject to payroll taxes (FICA)
• Employer gets a tax deduction when you exercise

Incentive Stock Options (ISOs)

• Available only to employees
• No regular tax when exercised
• Taxed when you sell the shares at capital gains rates (if holding requirements met)
• Holding requirements: 2 years from grant date AND 1 year from exercise date
• AMT risk: The spread at exercise is an AMT preference item

ISO Strategy

Exercise ISOs early (before the spread gets too large) to start the holding period and manage AMT risk.

Disqualifying Disposition

If you sell ISOs before meeting holding requirements:

• Converted to NSO treatment
• Taxed as ordinary income on the spread

Form W-2 and Form 3921

• NSO exercises are reported on your W-2
• ISO exercises are reported on Form 3921

Restricted Stock Units (RSUs)

• Taxed as ordinary income when vested
• FMV at vesting = ordinary income

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Have stock options from your employer? The tax timing decisions can be worth tens of thousands.