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IRS - Stock options

Stock options are a form of compensation that may result in taxable income when received, exercised, or sold.

Nicole Lacorte avatar
Written by Nicole Lacorte
Updated over 2 weeks ago

Types of Stock Options

There are two categories of stock options:

  • Statutory stock options – These include options granted under an employee stock purchase plan or an incentive stock option (ISO) plan.

  • Non-statutory stock options – These are options not granted under an employee stock purchase plan or ISO plan.

Statutory Stock Options

Receiving or exercising a statutory stock option generally does not result in taxable income. However, exercising an ISO may trigger the alternative minimum tax (AMT).

Taxable income or deductible loss occurs when the stock acquired through the option is sold. If special holding period requirements are not met, income from the sale must be reported as ordinary income. This income, treated as wages, is added to the stock’s basis to determine gain or loss upon sale.

Incentive Stock Options

Employers must issue Form 3921, Exercise of an Incentive Stock Option Under Section 422(b), which includes important details for calculating taxable capital gains or ordinary income.

Employee Stock Purchase Plans

Employees who sell stock acquired under an employee stock purchase plan must receive Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan Under Section 423(c), which provides necessary information for tax reporting.

Non-statutory Stock Options

The tax treatment of non-statutory stock options depends on whether their fair market value (FMV) can be readily determined.

Options with a Readily Determined FMV

If the option is actively traded on an established market, its FMV can be determined, and income is recognized at the appropriate time.

Options Without a Readily Determined FMV

Most non-statutory stock options do not have a readily determinable FMV. In such cases, no taxable event occurs upon granting the option. However, when exercised, the difference between the FMV of the acquired stock and the amount paid must be included in taxable income. When the stock is later sold, the transaction is generally reported as a capital gain or loss.

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