Strategies for Charitable Giving of Employee Stock Options
Disposition of stock is typically when the employee sells the stock, but stock can also be transferred to another person or donated to charity. A qualifying disposition for an ISO simply means that the stock acquired is disposed of over two years from the grant date and more than one year after the stock was transferred to the employee usually the exercise date. There is an additional qualifying criterion: the taxpayer must have been continuously employed by the employer granting the ISO from the grant date up to three months before the exercise date. Exercising an ISO is treated as income solely to calculate alternative minimum tax AMT , but it is ignored when calculating regular federal income tax.
The fair market value is measured on the day when the stock first becomes transferable or when the employee's right to the stock is no longer subject to a substantial risk of forfeiture.
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This inclusion of the ISO spread in AMT income only triggers if the employee continues to hold the stock at the end of the same year in which the option was exercised. If the stock is sold within the same year as its exercise, then the spread does not need to be included in AMT income. A qualifying disposition for an ISO is taxed as a capital gain at long-term capital gains tax rates and on the difference between the selling price and the cost of the option.
A disqualifying or non-qualifying disposition of ISO shares is any disposition other than a qualifying disposition. Disqualifying ISO dispositions are taxed in two ways: compensation income subject to ordinary income rates and capital gain or loss subject to the short-term or long-term capital gains rates. The amount of compensation income is determined as follows:.
Be aware that employers are not required to withhold taxes on the exercise or sale of incentive stock options. Accordingly, those who have exercised but not yet sold ISO shares at the end of the year may have incurred alternative minimum tax liabilities. Additionally, those who sell ISO shares may have significant tax liabilities not covered by payroll withholding. Taxpayers should send in estimated tax payments to avoid having a balance due on their tax return. Taxpayers may also want to increase the amount of withholding in lieu of making estimated payments.
ISOs are reported on Form There are three possible tax reporting scenarios. In this case, AMT income is increased by the spread between the fair market value of the shares and the exercise price. This amount can be calculated using data found on Form provided by their employer. Because income is being recognized for AMT purposes, there is a different cost basis in the shares for AMT than the shares for regular income tax purposes. It is advisable to 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 paid—the exercise or strike price.
The gross proceeds from the sale are required, which are given by the broker on Form B. Also required to be reported is the regular cost basis. This figure is the exercise or strike price, found on Form On the separate schedule D form, report gross proceeds from the sale, and the AMT cost basis—the exercise price plus any previous AMT adjustment.
IRS Form , will have a negative adjustment on line 2k to reflect the difference in gain or loss between the regular and AMT gain calculations. Refer to the Instructions for Form for details. Compensation income is reported as wages on IRS Form , line 1, and any capital gain or loss is reported on Schedule D and Form Your compensation income may already be included on Form W-2—the employer's wage and tax statement in the amount shown in box 1.
#3 The Best Time To Exercise ISOs
Sometimes, employers will provide a detailed analysis of this amount at the top portion of the W If compensation income is included on the W-2, simply report wages from box 1 on line 1 of your Form However, if the compensation income has not already been included on the W-2, then calculate compensation income and include this amount as wages on line 1 of Form in addition to the amounts from Form W This figure is shown on Form B received from your broker.
You will also show the cost basis for the shares. Use Form to report a negative adjustment for the difference between the AMT gain and the regular capital gain. IRS Form is used to provide employees with information relating to incentive stock options that were exercised during the year. Employers will provide the employee with one copy of this document for each exercise of ISOs during the calendar year.
So, if you had two or more exercises, you may receive multiple documents or a consolidated statement showing all your exercises. The formatting of this tax document may vary, but it will contain the following information:. This information is used to calculate the cost basis for the shares, the amount of income that needs to be reported for the alternative minimum tax, the amount of compensation income on a disqualifying disposition, and to identify the beginning and end of the special holding period to qualify for preferred tax treatment.
ISOs have a special holding period to qualify for capital gains tax treatment. The holding period is two years from the grant date, and one year after the stock was transferred to the employee. IRS Form shows the grant date in box 1 and shows the transfer date or exercise date in box 2. Add two years to the date in box 1, and add one year to the date in box 2.
If the ISO shares are sold after whichever date is later, that is a qualifying disposition, and any profit or loss will be a capital gain or loss taxed at the long-term capital gains rates. If the ISO shares are sold anytime before or on this date, that is a disqualifying disposition. The income from the sale is taxed partly as compensation income at the ordinary income tax rates and partly as capital gain or loss.
If an ISO is exercised and the shares are not sold before the end of the calendar year, report additional income for the AMT. The amount included for AMT purposes is the difference between the fair market value of the stock and the cost of the incentive stock option on the form To find the amount to include as income for AMT purposes, multiply the amount in box 4 by the number of unsold shares—usually the same as reported in box 5. From this product, subtract the exercise price—from box 3—multiplied by the number of unsold shares usually the same amount shown in box 5.
Report this amount on Form , line 2i. The cost basis of shares acquired through an incentive stock option is the exercise price, shown in box 3. The cost basis for an entire lot of shares is the amount in box 3 multiplied by the number of shares shown in box 5. This figure will be used on Schedule D and Form Shares exercised in one year and sold in a subsequent year have two cost bases: one for regular tax purposes and one for AMT purposes.
If ISO shares are sold during the disqualifying holding period, some of the gains are taxed as wages subject to ordinary income taxes, and the remaining gain or loss is taxed as capital gains. The amount to be included as compensation income, and typically included on Form W-2, box 1, is the spread between the stock's fair market value when you exercised the option and the exercise price.
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This change provides clarity that was lacking in the initial proposals. Employer Tax Deduction The proposals will provide an employer with a deduction in respect of the stock option benefit associated with non-qualified securities. These conditions include that: the employer is a corporation or a mutual fund trust ; the employer was the employer of the individual at the time the stock option was granted; the amount being claimed as a deduction is not claimed as a deduction by another corporation or mutual fund trust ; the stock option deduction would have been available to the employee if the underlying securities were not non-qualified securities; in the case of an employee not resident in Canada throughout the year, the stock option benefit was included in the employee's taxable income earned in Canada for the year; and the employer provided: notice in writing to the employee within 30 days after the option agreement was entered into that the securities is a non-qualified security; and notice to the Canada Revenue Agency of any non-qualified securities by filing a prescribed form with its income tax return for the year in which the stock options were granted.
Looking Forward The new legislative proposals will apply to employee stock options granted on or after July 1, , in most cases. In either case, affected employers should consider: the timing of granting stock options and other stock-based awards prior to these new rules coming into effect; and the notice requirements, including an appropriate method to notify employees of non-eligible securities. Manjit Singh. Anish Kamboj Articling Student.
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