- Ordinary income tax vs. capital gains tax
- Stock Options
- What Is the Tax Rate on Stock Options?
- IRAS | Stock Options
With NSOs, you are taxed when you exercise the stock options. You pay ordinary income and Medicare taxes and are subject to Social Security tax if you have not paid the yearly maximum on the difference between the fair market value at exercise and the grant price.
Ordinary income tax vs. capital gains tax
A stock option gives an employee the right to purchase stock at a predetermined price, regardless of the fair market value of the stock. A stock purchase option, available through an Employee Stock Purchase Plan , gives an employee the right to purchase company stock, sometimes at a predetermined discount from the fair market price. Although the plans are similar, they are not the same. Both kinds of plans can be either qualified for special tax treatment or unqualified.
Both can be offered to an exclusive group of participants as in the case of non-qualified Employee Stock Purchase Plans, or to all full-time employees under qualified plans. A stock option gives you the right to purchase the underlying shares represented by the option for a future period of time at a pre-established price. Stock options do expire. The expiration period varies from plan to plan. Once your options expire, they are worthless. There are often special rules for terminated, retired, and deceased employees.
These life events may accelerate the expiration.
Stock Options
Check your plan rules for details about expiration dates. There are usually special rules in the event you leave your employer, retire, or die. See your employer's plan rules for details. See Accepting and Declining Grants for details. The Summary page for stock option plans displays information about grant totals, unaccepted grants, and accepted grants.
What Is the Tax Rate on Stock Options?
From this page, you can view detailed information about a particular grant, accept or decline unaccepted grants, exercise accepted grants, or estimate the gain on a particular grant. You can view vesting schedule information, stock option details, and the option's current estimated value. The total value of exercisable options is equal to the previous business day's closing price minus the grant price multiplied by either the total options or exercisable options or 0, whichever is greater. The actual value at exercise may vary. The vesting schedule is a schedule of dates on which you receive the right of ownership for a specific number of stock options awarded as part of a stock option grant.
NSQs are treated as ordinary income for tax purposes at the time of exercise, assuming the fair market value at exercise is higher than the option price a positive spread. The employer, meanwhile, receives a tax deduction at the time of exercise based on the difference between the exercise price and the fair market value. Sounds pretty simple. The spread carries significant tax ramifications, forcing the employee to come up with money to pay the extra tax burden.
But since these individuals are not required to pay quarterly estimated taxes, they are hit with a sizable tax bill come April 15, Steinmetz says.
IRAS | Stock Options
What could be done to ease the pain? Some employees dig an even deeper hole, borrowing against the option profit a practice called a margin loan. When the tax bill came, they needed to borrow again, Ungar adds.
They then found that the bills on the loans were more than their regular income could support and consequently had to sell the stock, which had fallen precipitously in value. Ultimately, there was no place left to go other than to bankruptcy court. Although a capital loss from the stock upon sale would offset any capital gains, Kesner says this recourse is available only if there are capital gains. Without capital gains, the taxpayer is out of luck. While little could have been done post-exercise under this scenario, hindsight reveals the mistakes that fostered the problem. Needless to say, this strategy is only for the sophisticated and well-heeled who can afford to take the risk; not the rank and file.
From a tax complexity standpoint, NSQs are simple compared with ISOs, which present a veritable thicket of entanglements. When an ISO is exercised, the spread typically is subject to alternative minimum tax. The incentive hence the term incentive stock options is obvious: The longer the ISO stock is held, the lower the tax cost.
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The risk, of course, is that the stock value may plunge during the one-year holding period. Another perceived drawback is that even though the payment of AMT may create a tax credit in the future, it still amounts to a tax prepayment on a holding that later may be virtually worthless. But, instead of rising in price, the stock drops substantially and is now worth less than what you paid to exercise the options. You sell the stock for less than the exercise price, realizing a loss.
The upshot is clear. It saw it as a prepayment of a tax to be paid later, not the imposition of an additional tax. Ungar advocates reform legislation that would make the minimum tax credit fully refundable when the stock is sold, thus permitting the taxpayer to recovery fully any overpaid tax.
For more on this effort, log on to www. What can companies do to protect their option holders? Harvard Law School professor Christine Jolls, who has been studying stock options for the past year, says employers, financial planners and accountants must make a concerted effort to clear up the confusion. From a fiduciary standpoint, it is acceptable to explain to employees what happens taxwise under each of several different option exercise and sale scenarios, she says.
Not all companies do that, however. These people are being blindsided. Ungar has even developed a Web site, www. Kochis advises patience when exercising options. Wait until the options are about to expire, when the opportunity to buy cheap is about to run out, and then exercise. During this time, financial advisers can help you develop a strategy.
That is not a sound strategy. Taxes, he contends, should be a secondary consideration in determining when to exercise a stock option, despite the inducement to reap a lower rate. With Workiva, we've created a PowerPoint deck that helps you create your own scorecards -- quick reference reports used across organizations to update stakeholders on the performance of defined deliverables. Toggle search Toggle navigation. Breaking News. Sunk by Options How to avoid stock option tax catastrophes.