For the Last Time: Stock Options Are an Expense

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Fallacy 1: Stock Options Do Not Represent a Real Cost

Reviewed By Lea D. The options do not convey an ownership interest, but exercising them to acquire the stock does.

There are different types of options, each with their own tax results. Key Takeaways Stock options fall into two different categories: Statutory, granted under purchase plans or incentive stock options plans, and nonstatutory options that come with no plans.

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Income results when make money quickly and effortlessly sell stocks acquired by exercising statutory stock options, which produces the alternative minimum tax.

If you exercise the nonstatutory option, you must include the fair market value of the stock when you acquired it, less any amount you paid for the stock.

When you sell the stock, you report capital gains or losses for the difference between your tax basis and what you receive on the sale.

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Similarly, the exercise of the option to obtain the stock does not produce any immediate income as long as you hold the stock in the year you acquire it. Income results when you later sell the stock acquired by exercising the option.

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The adjustment is the difference between the fair market value of the stock acquired through the exercise of the ISO over the amount paid for the stock, plus the amount paid for the ISO if any. However, the adjustment is required only if your rights in the stock are transferable and not subject to a substantial risk of forfeiture in the year the ISO is exercised.

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And the fair market value of the stock for purposes of the adjustment is determined without regard to any lapse restriction when rights in the stock first become transferable or when the rights are no longer subject to a substantial risk of forfeiture. This is because the tax treatment becomes the same for regular tax and AMT purposes. The number of shares acquired is listed in box 5.

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The information on this form helps you determine option holder income amount of gain or loss, and whether it is capital or ordinary income. Tax Rules for Nonstatutory Stock Options For this type of stock option, there are three events, each with their own tax results: The grant of the option, the exercise of the option, and the option holder income of stock acquired through the exercise of the option. The receipt of these options is immediately taxable only if their fair market value can be readily determined e.

When you exercise the option, you include, in income, the fair market value of the stock at the time you acquired it, less any amount you paid for the stock. This is ordinary wage income reported on your W2, therefore increasing your tax basis in the stock.

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The Bottom Line Stock options can be a valuable employee benefit. However, the tax rules are complex.

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If you receive option holder income options, you should talk to your tax advisor to determine how these tax rules affect you. Article Sources Investopedia requires writers to use primary sources to support their work.

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These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other option holder income publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.

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