Stock Options
If you receive an option to buy stock, you may have income when you receive the option, when you exercise the option, or when you dispose of the option or stock received when you exercise the option. There are two types of stock options: statutory stock options and nonstatutory stock options. Generally, options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are considered statutory stock options. Nonstatutory stock options are not granted under an employee stock purchase plan or an ISO plan. Refer to Publication 525, Taxable and Nontaxable Income, for assistance in determining whether you have been granted a statutory or nonstatutory stock option.
If you are granted a statutory stock option, you generally do not include any amount in your gross income when you are granted or exercise the option. However, you may be subject to Alternative Minimum Tax in the year you exercise an ISO. For more information, refer to the Form 6251 Instructions. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. However, if you do not meet special holding period requirements, you will have to treat income from the sale as ordinary income. Refer to Publication 525 for specific details on the type of stock option as well as rules, for when income is reported and how income is reported for income tax purposes.
After exercising an ISO, you should receive from your employer a Form 3921 (PDF), Exercise of an Incentive Stock Option Under Section 422(b). This form will report important dates and values needed to determine the correct amount of capital and ordinary income (if applicable) to be reported on your return.
After your first transfer or sale of stock acquired by exercising an option granted under an employee stock purchase plan, you should receive from your employer a Form 3922 (PDF), Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c). This form will report important dates and values needed to determine the correct amount of capital and ordinary income to be reported on your return.
If you are granted a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined. If an option is actively traded on an established market, the fair market value of the option can be readily determined. Refer to Publication 525 for other circumstances under which the fair market value of an option can be readily determined and the rules for when income is reported for an option with a readily determinable fair market value. Most nonstatutory options do not have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there is no taxable event when the option is granted but the fair market value of the stock received on exercise, less the amount paid, is included in income when the option is exercised. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525, Taxable and Nontaxable Income.
Source: Internal Revenue Service
Last reviewed: September 20, 2013