Most people who are offered stock options to not understand the full benefits available from the opportunity. Along with those benefits are also some implications that should be considered, especially when it comes to your income tax. In this article, we are going to discuss some of the tax implications that are associated with stock options and how they may affect your filing at the end of the year.
Although there are a variety of stocks options that are available, they can be placed in 2 different categories. The incentive stock option (ISO) is one that gives preferred tax treatment in comparison with the other types of stock options. In essence, when action is taken on the stock option, regardless of whether it is sold or if capital gains need to be considered, it can affect your tax rate. The long-term capital gains tax rates would apply, provided the employee holds on to the shares for a minimum of one year after exercise or two years after grant. As far as the short-term capital gains are concerned, it is the same as are ordinary tax rate.
Nonqualifying Tax Options (NQSO) - With this type of stock option, you are going to end up paying taxes. If the employee exercises options, you're going to pay an ordinary tax rate. The employer receives a tax deduction upon the employee exercising the option and if the options are held for a minimum of one year, the employee will end up paying long-term capital gains tax.
Incentive Stock Options (ISO) - The tax implications for incentive stock options are better, because the employee does not pay tax when they exercise options. The employer, on the other hand, does not get a deduction at that time. If the options are sold after one year, the employee will pay long-term capital gains tax.
There are penalties associated with selling incentive stock options within the first year after they take ownership. The purpose of this type of option is to reward the employee, so if they sell the option within the first year, they will end up paying income tax rather than paying long-term capital gains tax, which they would pay if they hold on to the options for a minimum of one year.
Additional options may also be available to employees, all of which may have their own tax implications. For example, stock may be offered as part of a 401(k) retirement plan and that money can be set aside without being taxed until the individual reaches retirement age. They may also match the contribution of the employee into their 401(k) retirement plan with options. Additionally, the alternative minimum tax (AMT) may come into effect when an employee receives large gains as a result of their stock options.
If you have any questions about the tax implications of stock options, you can contact us for more information. We can help you with your financial needs and in aligning your stock options for maximum benefit.