Tax and Stock Options

January 13, 2005 3:49 PM

I have exercised stock options and taken possession of a small number of shares. I have not sold anything, but am wondering how screwed I am, tax-wise. First, do I have to declare the value of the stock as "income" for the year that I acquired it? Second, if I should sell it, do I add the money I receive from that sale to my regular taxable income? Do I deduct the amount I paid in? Is the net difference subject to other taxes? Is this handle-able by an average person or do I need an accountant?
posted by scarabic to work & money (6 answers total)

There is a preliminary question that you need to answer. As stock options, are these stocks restricted in any sense? Many companies offer these options with conditions, i.e. if you quit within 3 years of exercising, you must resell the stock to them, etc.

First, do I have to declare the value of the stock as "income" for the year that I acquired it?

If you own the stock with no restrictions whatsoever (see above), then yes.

If you are under restrictions, then no. However, if you expect the stock value to rise significantly in the near future, you should do this. However, you must notify the company that you are doing so within thirty days of exercising the stock options. (By doing this, you take a "basis" in the stock at its currently low price, and the significant increase in value which you get when you sell it later will be taxed as capital gains, which is taxed at a lower rate than ordinary income). HOWEVER, if you do not gain complete ownership of the stock (i.e. you quit and do not receive the full value of the stock) then you cannot regain the tax that you have already paid.

Second, if I should sell it, do I add the money I receive from that sale to my regular taxable income? Do I deduct the amount I paid in?

You always deduct the amount you paid for the stock (your "basis" in the property). However, most stock sales can be characterized as capital gains, which are taxed at a lower rate than ordinary income, if certain conditions are met. If those conditions are met, you do not include it as ordinary income, but as capital gains.

I am not an accountant or tax lawyer! I did, however, just take a course in federal income tax law, and we covered this specific situation. I recommend speaking to someone in your company about it immediately, especially if these stock options are subject to certain conditions and may significantly increase in value.
posted by MrZero at 4:19 PM on January 13, 2005

Quick addendum. In my answer to your first question, please change the first sentence of the second paragraph to this:

If you are under restrictions, then you include the value of the stock which you are vested in ownership. For example, if you must remain at the company for 5 years to get full ownership of the stock, but you get 1/5 ownership for each year you stay there, then you include the value of the first 1/5 in the first year, the second 1/5 in the second year, etc. The idea is that you include it when you own it.
posted by MrZero at 4:23 PM on January 13, 2005

You should talk to an accountant straight away. As far as I understand it - if you were granted stock options and you exercise and hold them - you are responsible for tax on the gain between the strike price of the shares and the current market value on exercise. You are liable for the tax even before you sell the shares. If you are employed and making a decent living - this kind of occurrence can easily push you into AMT - which is a scary scary place.

In all my years of being granted and exercising options I have always been warned against exercising and holding. You either buy when the current market value is the same as the grant price (this is why some companies allow you to buy shares on grant - before you've technically vested) or if you miss that window - do a same day sale. IIRC, when you realize the gain at the same time you buy them - you are only liable for straight income tax on the profit.

I am not a tax person - just someone who jumped around a lot in the valley the last 10 years. If they were cool - you can talk to your stock person - but you're likely better off calling a tax accountant.
posted by Wolfie at 4:59 PM on January 13, 2005

Here is the part of the Internal Revenue Code that, in theory, answers your question.

Translation into English: talk to a tax accountant. It was irresponsible of whoever gave you the options not to provide you with a statement telling you what their legal status (ISO, ESOP, NQSO) was and what the basic tax consequences of exercising them would be. A standard tax-preparation program will probably be able to handle them correctly when it comes time to file your taxes, but a tax accountant will be able to advise you of the consequence of doing various things. (In particular, for some kinds of options, the tax consequences may change dramatically depending on how long you wait between exercising them and selling your shares.)
posted by grimmelm at 8:17 PM on January 13, 2005

Reform AMT, this shit sucks.
posted by billsaysthis at 9:36 PM on January 13, 2005

Thanks for the info. I'm going to an accountant, apparently. I think I may have created a disadvantageous timing situation for myself, but as I was leaving the company, I didn't have another option. I will seek professional help right quick! Thanks all.
posted by scarabic at 10:44 PM on January 13, 2005