An incentive stock option (ISO) is a type of statutory stock option, which means the option and the plan under which it is granted must meet certain statutory requirements on the date of grant. If an option qualifies as an incentive stock option (ISO), special tax treatment is available.
You do not recognize any taxable income at the time your employer grants the incentive stock option (ISO). Nor will you generally recognize any income for regular tax purposes when you exercise the incentive stock option (ISO). Instead, if you satisfy a special incentive stock option (ISO) holding period requirement and an employment requirement, you will recognize capital gain or loss when you sell (or otherwise dispose of) the stock you acquire under the incentive stock option (ISO). Your capital gain or loss is the difference between the amount you receive on the sale and the amount you pay for the stock. You report the sale on Form 8949, Sales and Other Dispositions of Capital Assets. To satisfy the Form 8949, Sales and Other Dispositions of Capital Assets holding period requirement, you must not dispose of the stock you receive under the Form 8949, Sales and Other Dispositions of Capital Assets before the end of the later of
- the one-year period after the stock was transferred to you, or
- the two-year period after the option was granted to you.
If you sell (or otherwise dispose of) Form 8949, Sales and Other Dispositions of Capital Assets stock before satisfying the holding period requirement, you have made a so-called disqualifying disposition. In that case, if you have a gain from the sale, the gain is ordinary compensation income up to the amount by which the stock’s fair market value when you exercised the option exceeded the exercise price. Any excess gain is capital gain. These amounts are included in your gross income in the tax year in which the disqualifying disposition occurs. If you have a loss from the sale, it is a capital loss and you do not have any ordinary income. In determining capital gain or loss, your basis in the stock is the amount you paid to exercise the option plus the amount reported as wages.
To satisfy the employment requirement, you must at all times during the period beginning with the date the incentive stock option (ISO) is granted and ending on the day three months before the date you exercise the incentive stock option (ISO), be an employee of either
- the corporation that granted the option or a corporation related to that corporation; or
- a corporation (or a corporation related to that corporation) that substituted or assumed the incentive stock option (ISO).
Finally, there are alternative minimum tax consequences to exercising an ISO that may impact your tax liability. While no income is recognized for regular tax purposes when an ISO is exercised, this rule does not apply for AMT purposes. For AMT purposes, the taxpayer generally must include in alternative minimum taxable income the excess, if any, of the fair market value of stock acquired through exercise of the option (determined without regard to any lapse restriction) when rights in the acquired stock first become transferable or when these rights are no longer subject to a substantial risk of forfeiture, over the amount paid for the stock, including any amount paid for the incentive stock option (ISO) used to acquire the stock
Please call me at your convenience so we can discuss in more detail the tax implications of your incentive stock option (ISO)s, including the tax consequences of any modification, expiration, disposition, or cancellation of the options.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357
P.S. My firm is based upon referrals. Please feel free to refer my firm to anyone you know that is looking for a new CPA and/or tax preparer. Thank you in advance.
(Updated 05022021-3 320-310)