Stock Acquired with an Incentive Stock Option (ISO) in header of articles
Stock Acquired with an Incentive Stock Option (ISO) in content page of articles
If you sell stock you got by exercising incentive stock options (ISOs), the type of tax you'll pay depends on your holding period. The holding period is:
How long you held the stock after you exercised the option
How long after the option was granted that you sold the stock
Part of the stock sale’s profit will be reported as ordinary income (W-2 income) if either of these apply:
You’d held the stock you bought when you exercised the option for 1 year or less.
You’d held the stock for less than 2 years after the option was granted to you.
Your employer should include the amount reported as ordinary income in your total earnings on your W-2. Any remaining gain is reported as a capital gain. If you sold the stock for a loss, report the entire loss as a capital loss.
Report stock sale profits as a capital gain or report losses as a capital loss if both of these apply:
You’d held the stock you bought when you exercised the option for more than 1 year.
You’d held the stock for 2 or more years after the option was granted to you.
Ex: Rob’s employer granted him an ISO on March 11, 2010, to buy 100 shares of stock at $10 a share. At the time Rob received this ISO, his company's stock was trading for $10 a share. When he exercised the option on Jan. 14, 2011, the stock was trading at $12 a share. On Jan. 24, 2012, he sold the stock for $15 a share.
He had held the stock for less than 2 years after being granted the option (from March 11, 2010, to Jan. 24, 2012). So, part of his profit will be treated as W-2 income and part will be treated as a capital gain. The part treated as W-2 income is the profit he made from the date of grant to the date of exercise:
$12 (market value on date of exercise) - $10 (amount paid for the stock) x 100 shares = $200
So, $200 of the profit is taxable as ordinary wage income on his W-2. The part treated as a capital gain is the profit he made from the date of exercise to the date of sale:
$15 (market value on date of sale) - $12 (market value on date of exercise) x 100 shares = $300
So, he must treat the $300 as a capital gain.
Reporting the Sale
If you follow IRS rules when you report the sale of stock bought through an ISO, you’ll avoid being taxed twice on the same income.
The broker your employer uses to handle the stocks will send you a Form 1099-B. The form will include:
Number of shares sold
Price you sold the stock for
Your net proceeds (in most cases)
Read the 1099-B carefully to see if the expenses related to the sale were excluded from the reported proceeds. If expenses weren't included, include them in the cost (or basis) of the stock you sold.
To learn more, see the Sale Expenses tax tip.
You might receive a statement from your employer showing the amount included in your W-2 income (if any). If you're not sure if any of your gain was in your W-2 income, check with your employer.
To learn more, see IRS Publication 525: Taxable and Nontaxable Income.
Incentive Stock Options and the Alternative Minimum Tax
Incentive stock options can have Alternative Minimum Tax (AMT) implications. When you exercise the option and don't sell it in the same year you exercised it, you must add the difference between these 2 amounts to your AMT income:
Amount you paid for the stock
Stock’s fair market value on the day you exercised your option
The fair market value on the day you exercised the option is your AMT basis. When you sell your stock, use the AMT basis for calculating the AMT gain or loss. For AMT purposes, your gain will be lower or your loss will be greater than for regular income tax purposes. Report the difference as an AMT gain / loss adjustment on Form 6251: Alternative Minimum Tax, Part II.
Keep a record of the AMT basis in your files so that you can correctly figure the AMT gain or loss when you sell the stock. The capital loss deduction for net AMT losses is limited to $3,000.
To learn more, see IRS Form 6251 instructions.
Ex: Rob’s basis in the stock for regular tax purposes is the price he paid for it -- $10 per share for 100 shares. His AMT basis is $12 per share, which was the market value on the day he exercised the option.
If Rob didn't sell anything when he exercised his option on Jan. 14, 2012, he didn't need to report any income. However, when he exercised the option, AMT income existed that he needed to report. The AMT income he generated when he exercised the option on Jan. 14, 2012, was $200:
$12 (market value on date option exercised) - $10 (amount paid for stock) x 100 (shares) = $200
Rob’s basis in the stock, for regular tax purposes, is the price he paid for it -- $10 per share. His AMT basis is $12 per share, which was the market value on the day he exercised the option. When he finally decides to sell the stock, he'll use this AMT basis to calculate the AMT gain or loss.
To help figure any AMT on the exercise of your ISO, see your Form 3921. Your employer must provide a Form 3921 to you by Jan. 31 of the year after you exercise your stock options.