Tax on exercise of nonqualified stock option

Tax on exercise of nonqualified stock option

Posted: denlis Date: 30.06.2017

On the surface, the tax rules associated with non-qualified stock options are relatively straightforward. Upon receipt of non-qualified stock options, no taxes are due.

Exercising Nonqualified Stock Options

Furthermore, these stock options are not taxable until you exercise your shares. And when they do, taxes will be due.

Typically, there are two types of taxes to consider during the lifespan of your non-qualified stock options:. How much income is subject to compensation income and how much is subject to capital gains depends on several factors, including issue price, exercise price, holding period, and overall exercise strategy.

One attractive feature of non-qualified stock options is that the owner is not required to pay any tax when the options are issued.

This allows the owner to participate in the unlimited upside of the stock price, all while deferring potential tax liability. Furthermore, when the stock options vest, no taxes are due this is substantially different from their restricted stock cousins. Upon exercise of non-qualified stock options , taxes will be incurred. Specifically, the option owner will need to claim as compensation income the value of the bargain element.

The bargain element is calculated as the difference between the grant price of the stock option and the exercise price of the stock option, multiplied by the number of shares. In addition, this compensation income is reportable regardless of whether or not the owner continues to hold the shares after exercise or decides to sell them immediately. Deciding whether to hold shares brings into question the decision of a cash exercise or a cashless exercise.

In other words, can the option owner afford to exercise these shares? Upon exercise, the cost basis of the shares is set and is equal to the exercise price times the number of shares exercised.

Upon exercise, you now become the outright owner of the shares. As the owner, you have the ability to sell the shares immediately or hold them indefinitely although you may want to consider how concentrate equity fits into your financial plan. The period of time for which you retain ownership and the value of the shares dictate how they will be taxed. Specifically, the shares will be subject to capital asset tax rates. These rates are different for short-term holding periods less than one year and long-term holding periods anything that is not short-term.

Assuming a short-term holding period, in which you sell the shares less than one year after exercise, any gain will be taxed at ordinary income rates. Assuming a long-term holding period of one year or more, any gain over the cost basis is subject to preferential long-term capital gains treatment. Below is a hypothetical example. In reality, this would mean the share values are the same, once prior to a one-year hold and once after the one-year holding period.

Stock Options and the Alternative Minimum Tax (AMT)

While this illustration indicates a tax scenario, many factors should be considered if continuing to hold stock shares after exercise. Taxes are simply one factor in what is a potentially complicated planning question. As mentioned earlier in this article, the taxation of non-qualified stock options is relatively simple.

At exercise, the spread between the grant price and the exercise price is taxed the same as your other wage income. However, tax planning is only one piece of sound stock option planning.

In addition to how these fit into your overall financial plan, you may want to consider other non-qualified stock option strategies and the discussion of a cash vs.

Get The Most Out Of Employee Stock Options

Tax services are not offered through, or supervised by Lincoln Investment, or Capital Analysts. The above figures are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

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tax on exercise of nonqualified stock option

Daniel, this is an excellent article and clarifies so much for me. I do, however, have one question. Am I doing something wrong or misunderstanding? Please let me know. Email will not be published required. Notify me of follow-up comments by email.

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tax on exercise of nonqualified stock option

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