Stock Options According to the IRS
If you receive an option to buy stock as payment for your services, you may have income when you receive the option, when you exercise the option, or when you dispose of the option or stock received when you exercise the option. There are two types of stock options:
Options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are statutory stock options.
Stock options that are granted neither under an employee stock purchase plan nor an ISO plan are non-statutory stock options.
If your employer grants you a statutory stock option, you generally do not include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise a stock option. You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition.
Statutory stock options are most often either: a) incentive stock options or b) employee stock purchase plans. After exercising an incentive stock option, you should receive a Form 3921 from your employer. In an employee stock purchase plan, you should receive a Form 3922 from your employer.
Some stock options can be non-statutory. If your employer grants you a non-statutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined. If an option is actively traded on an established market, you can readily determine the fair market value of the option. However, not all non-statutory stocks have a readily determinable fair market value.
For non-statutory options without a readily determinable fair market value, there's no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss.
The professionals at The Center for Financial, Legal, and Tax Planning are more than knowledgeable with regards to the tax aspects of stock options in addition to other forms of income taxation. Please contact us at (618) 997-3436 with any questions.