Exercising options to buy company stock at below-market price triggers a tax bill. How much tax you pay when you sell the stock depends on when you sell it. The tax catch is that when you exercise the options to purchase stock but not before , you have taxable income equal to the difference between the stock price set by the option and the market price of the stock. In tax lingo, that's called the compensation element. The compensation element is basically the amount of discount you get when you buy the stock at the option exercise price instead of at the current market price.
You calculate the compensation element by subtracting the exercise price from the market value. The market value of the stock is the stock price on the day you exercise your options to buy the stock.
The exercise price is the amount that you can buy the stock for according to your option agreement. Your company must report the compensation element as an addition to your wages on your Form W-2 in the year you exercise the options.
You will owe income tax and Social Security and Medicare taxes on the compensation element. If you are given an option agreement that allows you to purchase 1, shares of company stock, you have been granted the option to purchase stock.
How you report your stock option transactions depends on the type of transaction. Usually, taxable Nonqualified Stock Option transactions fall into four possible categories:.
In this situation, you exercise your option to purchase the shares but you do not sell the shares. Why is it reported on your W-2? What if for some reason the compensation element is not included in Box 1? Because you sold the stock right after you bought it, the sale counts as short-term that is, you owned the stock for a year or less—less than a day in this case.
Then you have to determine if you have a gain or loss. How did we determine these amounts? If not, you must add it to Form , Line 7 when you fill out your tax return.
The stock sale is considered a short-term transaction because you owned the stock less than a year. How did we get these figures? When you are granted nonqualified stock options, get a copy of the option agreement from your employer and read it carefully.
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Start for Free Sign In. Skip To Main Content. Compensation element The compensation element is basically the amount of discount you get when you buy the stock at the option exercise price instead of at the current market price.
When do I have to pay taxes on my options? Usually, taxable Nonqualified Stock Option transactions fall into four possible categories: You exercise your option to purchase the shares and you hold onto the shares.
You exercise your option to purchase the shares, and then you sell the shares the same day. You exercise the option to purchase the shares, then you sell them within a year or less after the day you purchased them. You exercise the option to purchase the shares, then you sell them more than a year after the day you purchased them. Each of these four scenarios has its own tax issues as the following four tax examples show.
You exercise your option to purchase the shares and hold onto them. You exercise your option to purchase the shares and then sell them the same day. The cost basis is your original cost the value of the stock, consisting of what you paid, plus the compensation element that you have to report as compensation income on your Form You exercise the option to purchase the shares and then sell them within a year or less after the day you purchased them. Because you sold the stock, you must report the sale on your Schedule D.
You exercise the option to purchase the shares, then sell them more than a year after the day you purchased them.
Things to remember when granted stock options When you are granted nonqualified stock options, get a copy of the option agreement from your employer and read it carefully.
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