Companies offer stock options to their employees as a form of compensation and to provide them with ownership of the company. These options provide the opportunity to purchase company stock in the future at a set price.
There are two main types of stock options:
ISO-Incentive Stock Options: Granted to employees and must be exercised within 90 days.
- There are no income tax consequences when you exercise your options (purchase the stock at a specified exercise price) unless the transaction triggers the Alternative Minimum Tax (AMT). AMT is an additional tax calculated for individuals earning more than $75,900 per individual or $118,100 for couples filing jointly in 2022, and $81,300 for single filers or $126,500 for couples filing jointly in 2023.
NSO-Nonqualified Stock Options: Granted to employees and non-employees.
- For employees, the gain between the exercise price (the price you paid) and the market price on the day you exercise the option is treated as ordinary income and is added to your W-2 income.
- For non-employees, the gain calculation will be the same as employees, but the individual will receive a 1099 from the company instead of a W-2.
Neither are taxable at the time they are granted.
General Strategies for Managing Stock Options
Delay and hold: You hold on to the options, knowing that you can exercise them at a later date. Typically, you have ten years, if still employed by the issuing employer, to exercise your stock options. This is not a viable strategy if you are considering terminating employment because under most plan rules, you will have no more than 3 months to exercise any vested stock options after you leave the company.
Exercise and hold: You exercise the stock options and buy the company shares to capture dividends or in anticipation of the company stock increasing in value.
Exercise and sell: You exercise the stock options and simultaneously sell the shares at the current market price. This strategy is most common if you want to capitalize on a gain between the exercise price and the market price of the company stock.
Cashless Exercise: This is a form of exercise and sell for individuals that don’t have the resources to purchase company shares at the time of exercise. This strategy uses a brokerage firm to purchase and immediately sell the company's stock. Part of the proceeds will be allocated to the brokerage firm to cover any fees for this transaction, and the remainder will be a capital gain.
83(b) Election: A tax-saving election that can start the holding period of restricted stock or stock options. When the stock is sold, it will be treated as a capital gain instead of ordinary income. This election must be made no later than 30 days after the options have been granted.
For further guidance, please contact ADKF, and we would be glad to assist you in the tax treatment of your company stock options.