Adjusting cost basis for stock options

This fair market value is also the amount to treat as income on your tax return.

Restricted Stock Units (RSU)

When you exercise the options and acquire additional shares of stock, the basis of the added shares is equal to your basis in the stock options plus the price you pay for the shares. The tax-free stock options you receive, such as those your employer grants you as an incentive or through an employee stock purchase plan, have a tax basis of zero. This means that when you exercise these options, your basis in the new or added shares is the exercise price -- the price the option lets you buy the shares for.

When a stock option isn't taxable, it doesn't affect the basis of the added shares, but it may for your old shares. If at the time you receive the stock option, its fair market value is 15 percent or more of the the market price of the shares you already own, you must allocate the basis you have in them between the old stock and the stock options. You do this by dividing the old stock's market value on the day you receive the options by the sum of this market value plus the value of the options.

You then multiply the result by your total basis in the old shares to arrive at the new basis amount for old shares. If the total value of your options is less than 15 percent of the total value of your old shares, the basis of each additional share you acquire with the option is still the exercise price. But in this case, you don't have to adjust the basis of your old shares unless you want to. If you do, the Internal Revenue Service requires you to attach an explanatory statement to your tax return.

Michael Marz has worked in the financial sector since , specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.

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These returns cover a period from and were examined and attested by Baker Tilly, an independent accounting firm. Visit performance for information about the performance numbers displayed above. More Articles 1. Strike prices are set at the time the options are granted, but options usually vest over a period of time.

If the stock increases in value, an ISO provides employees with the ability to purchase stock in the future at the previously locked-in strike price. This discount in the purchase price of the stock is called the spread. Income from ISOs are taxed for regular income tax and alternative minimum tax, but are not taxed for Social Security and Medicare purposes. How ISOs are taxed depends on how and when the stock is sold or disposed.

Disposition of stock is typically when the employee sells the stock, but it can also include transferring the stock to another person or giving the stock to charity.

A qualifying disposition of ISOs simply means that the stock, which was acquired through an incentive stock option, was disposed more than two years from the grant date and more than one year after the stock was transferred to the employee usually the exercise date. An additional qualifying criteria is that you must have been continuously employed by the employer granting the ISO from the grant date up to 3 months prior to the exercise date. Exercising an ISO is treated as income solely for the purpose of calculating the alternative minimum tax AMT , but is ignored for the purpose of calculating the regular federal income tax.

The fair market value is measured on the date when the stock first becomes transferable or when your right to the stock is no longer subject to a substantial risk of forfeiture. This inclusion of the ISO spread in AMT income is triggered only if you continue to hold the stock at the end of the same year in which you exercised the option. If the stock is sold within the same year as exercise, then the spread does not need to be included in your AMT income.

A qualifying disposition of an ISO is taxed as a capital gain at the long-term capital gains tax rates on the difference between the selling price and the cost of the option. Disqualifying ISO dispositions are taxed in two ways:. Be aware that employers are not required to withhold taxes on the exercise or sale of incentive stock options.

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Accordingly, persons who have exercised but not yet sold ISO shares at the end of the year may have incurred alternative minimum tax liabilities. And persons who sell ISO shares may have significant tax liabilities that may not necessarily be paid for through payroll withholding. Taxpayers should send in payments of estimated tax to avoid having a balance due on their tax return.

You may also want to increase the amount of withholding in lieu of making estimated payments. Incentive stock options are reported on Form in three possible ways:. Increase your AMT income by the spread between the fair market value of the shares and the exercise price. This can be calculated using data found on Form provided by your employer.

The calculated spread is reported on Form Because you are recognizing income for AMT purposes, you will have a different cost basis in those shares for AMT than for regular income tax purposes. Accordingly, you should keep track of this different AMT cost basis for future reference. For regular tax purposes, the cost basis of the ISO shares is the price you paid the exercise or strike price.

Report the gain on your Schedule D and Form