Employee Stock Options
The price of these stock options is typically the same as the market value of the shares when the company makes such options available, also known as the grant date. Employees will have a deadline to exercise these options, known as the expiration date. If the date passes without the options being exercised , the employee would lose those options. That means employees stand potentially to acquire stock at a discount if the grant price—also known as the exercise price—is lower than later market prices.
However, the employee will pay income tax against the difference with a market share price of the stock when the option is exercised. Once the options are exercised, the employee can choose to sell the shares immediately or retain them. As with other types of stock options, non-qualified stock options can be a way to reduce the cash compensation that companies pay directly to their employees while also connecting part of their compensation to the growth of the companies.
The terms of the options may require employees to wait a period of time for the options to vest.
Furthermore, the employee could lose the options if they left the company before the stock options are vested. There might also be clawback provisions that allow the company to reclaim NSOs for a variety of reasons. This can include insolvency of the company or a buyout. For smaller and younger businesses with limited resources, such options that can be offered in lieu of salary increases. They can also be used as a recruiting tool to make up for shortcomings in the salaries offered when hiring talent.
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Learn more. Yes, there are tax implications — and they can be significant.
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Exercising stock options is a sophisticated and sometimes complicated transaction. Before you consider exercising your stock options, be sure to consult a tax advisor. Fidelity works to make your exercise-and-sell transaction simple and seamless for you, so it appears to you to be a single transaction. For federal income tax purposes however, an exercise-and-sell transaction cashless exercise of non-qualified employee stock options is treated as two separate transactions: an exercise and a sale.
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The first transaction is the exercise of your employee stock options, in which the spread the difference between your grant price and the fair market value of the shares at the time of exercise is treated as ordinary compensation income. It is included on your Form W-2 you receive from your employer.
The fair market value of the shares acquired is determined under your plan rules. The second transaction — the sale of the shares just acquired — is treated as a separate transaction. This sale transaction must be reported by your broker on Form B, and is reported on Schedule D of your federal income tax return.
Topic No. Stock Options | Internal Revenue Service
The Form B reports the gross sales proceeds, not an amount of net income; you will not be required to pay tax twice on this amount. Your tax basis of the shares acquired in the exercise is equal to the fair market value of the shares minus the amount you paid for the shares the grant price plus the amount treated as ordinary income the spread. In an exercise-and-sell transaction therefore, your tax basis will ordinarily be equal to, or close to, the sale price in the sale transaction. As a result, you would not ordinarily report only minimal gain or loss, if any, on the sales step in this transaction although commissions paid on the sale would reduce the sales proceeds reported on Schedule D, which would by itself result in a short-term capital loss equal to the commission paid.
An exercise-and-hold transaction of non-qualified employee stock options includes only the exercise part of those two transactions, and does not involve a Form B. You should note that state and local tax treatment of these transactions may vary, and that the tax treatment of incentive stock options "ISOs" follows different rules. You are urged to consult your own tax advisor regarding the tax consequences of your stock option exercises.
A disqualifying disposition occurs when you sell shares prior to the specified waiting period, which has tax implications. For more information, contact your tax advisor. The goal of the AMT is to ensure that anyone who benefits from certain tax advantages will pay at least a minimum amount of tax. For more information about how the AMT may affect your situation, contact your tax advisor.
The taxes owed on the gain fair market value at the time you sell, less the grant price , minus brokerage commissions and applicable fees from an exercise-and-sell transaction are deducted from the proceeds of the stock sale. Your employer provides tax-withholding rates. See Exercising Stock Options for more information. You may want to contact your tax advisor for information specific to situation.
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