Employee Stock Options

On December 1, 2020, the fair market value of the stock is $40 per share, and Marcus decides to exercise his option. If he purchased the 100 shares of stock at fair market value, he would have to pay $4,000. Instead, he only pays $1,500. What is Marcus's recognized compensation?

$2,500 ($4,000 fair market value − $1,500 option price = $2,500).

What are the three tax rates for long term capital gain?

0, 15, 20

2 benefits of statutory stock option

1. Does not have to include any amount in their income when they receive a statutory stock option. 2. Does not have to include any amount in their regular, taxable income when they exercise a statutory stock option.

4 principles for nonqualifying disposition from an ISO

1. If the stock is sold at a gain, the gain is treated as ordinary income from compensation up to the amount by which the fair market value at exercise exceeded the option price. 2. Any amount treated as ordinary income from compensation in the previous step is added to the basis of the stock to determine the capital gain or loss. 3. Any excess gain is capital gain. 4. If the stock is sold at a loss, it is a capital loss

two types of statutory stock options

1. Incentive stock options (ISOs). 2. Options granted under employee stock purchase plans (ESPPs)

What are some ways TCJA indirectly impacted equity compensation?

1. TCJA lowered tax rates for many, impacting the decision to exercise and/or sell employee stock option 2. TCJA and other laws established higher income phase-out limits for certain deductions and credits 3. Relatively low capital gain tax rates have likely played a key role in the escalation of stock option grants

the following requirements must be met to qualify for the election to defer income when acquiring the stock

1. The corporation must provide the stock option or restricted stock units to at least 80% of U.S. employees. 2. The recipients must have the same rights and privileges to receive the stock. 3. The employee must not have the ability to receive cash in lieu of the company stock.

If a nonstatutory stock option is not traded on an established market, what four requirements need to be met so that the fmv can be determined?

1. The taxpayer can transfer the option. 2. The taxpayer can immediately exercise the option in full. 3. The option was not issued with any significant conditions or restrictions. 4. The fair market value of the option privilege can be readily determined

Holding period requirements for ESPPs

1. They hold the shares for more than one year after the purchase date. 2. They hold the shares for more than two years after the beginning of the offering period (the window of time during which the automatic payroll deductions are collected and the date the shares are purchased).

For ISOs, the taxpayer must hold the underlying stock until the end of the later of:

1. Two years after the option was granted. 2. One year after the stock was transferred to the taxpayer (the exercise date).

2 types of employee stock options

1. statutory 2. nonstatutory (aka nonqualified)

The taxpayer generally does not need to include the information reported on Form 3921 on their tax return until they sell the stock, or unless they are subject to the alternative minimum tax (AMT) in the year the option was exercised.

1. they sell the stock, or 2. unless they are subject to the alternative minimum tax (AMT) in the year the option was exercised.

From for reporting Proceeds from Broker and Barter Exchange Transactions

1099B

Where on income dox can you find income from nonstatutory stock options?

1099NEC or W-2 box 1 and box 12 code V

What document sent from employer reports when an employee exercises incentive stock option?

3291, Exercise of an Incentive Stock Option Under Section 422(b)

Cashless exercise:

A process by which a taxpayer exercises an employee stock option without using their own funds to purchase the underlying stock

Cash exercise

A transaction in which a taxpayer exercises an employee stock option, and they use their own personal funds to purchase the stock.

Why do you need to make an adjustment basis on the sale of nonstatutory stock options?

After Jan 1 2014, brokerage firms can no longer increase the cost basis to account for income reported on the taxpayer's Form W-2.

Name of Form 6251

Alternative Minimum Tax -- Individuals

AMTI

Alternative Minimum Taxable Income

What is the exemption for AMT?

An amount that can be deducted from AMTI and phase outs for AMT exemption

Elison, an employee of Cedar Corporation, was granted an incentive stock option. If Elison exercises his option and purchases shares of the company stock, how long must he hold the shares in order to receive the most advantageous tax treatment under a qualifying disposition?

At least two years after he receives the option or at least one year after he exercises it; whichever is later.

Where might an employer report the amount received from sell of a nonqualified disposition other than box 1?

Box 14; term ISODD

What are the tax consequences of selling stock from a nonstatutory stock option?

Capital gain or loss

What is a tax benefit associated with statutory stock options?

Employees do not have to include any amount in income when the option is granted

How do changes in the AMT calculation affect taxpayers who exercise ISO's?

Fewer taxpayers will be required to pay the alternative minimum tax because the exemption amounts are higher than they were in prior years.

Why should you keep 3291 even if you did not sell your stock this year?

Form 3921 includes important information about the fair market value of the stock at the time of purchase

On what form is the AMT adjustment for incentive stock options made?

Form 6251 on line 2i

qualifying disposition (for ISOs)

If the taxpayer meets the holding period requirement when they sell or otherwise dispose of the stock, they will receive more favorable tax treatment.

Where can you find more info about AMT?

Instructions for Form 6251

What is the one notable exception for AMT basis adjustment?

No adjustment is required if the taxpayer sells the stock in the same year they exercise the option.

statutory stock options

Options granted under an employee stock purchase plan or an incentive stock option plan

restricted property

Property with certain restrictions impacting its value

How are statutory and nonstatutory stock options different in their tax consequences?

Statutory stock options receive more advantageous tax treatment, but there are more restrictions associated with them. Nonstatutory stock options receive less favorable tax treatment, but they are more commonly issued because they have fewer restrictions.

nonstatutory stock options

Stock options that are not granted under an employee stock purchase plan or an incentive stock option plan

Why does an exemption exist for AMT?

The AMT system was not designed to apply to lower and middle-income taxpayers with relatively small AMT adjustments

underlying stock

The actual stock that underlies, or gives value to, an option. This refers to the stock of a corporation that an option can be used to purchase

Why might you need to make an adjustment for a nonqualified disposition of ESPP?

The basis of the stock reported on Form 1099-B may not include adjustments for amounts reported as ordinary income. It may be necessary to make an adjustment on Form 8949 using adjustment code "B" in column (f). The adjusted amount should then be reported in column (g).

exercise date

The date on which the employee uses their option, or right, to purchase the underlying stock.

grant date

The date on which the employer grants the option to purchase the stock.

sale date

The date on which the underlying stock is sold

What is the tax consequence of receiving stock as payment?

The employee must therefore include the fair market value of the stock in their income in the year they receive the stock.

ESPP Qualifying Disposition at discount: The taxpayer's ordinary income will be the lesser of:

The excess of fair market value at the time the option was granted over the option price. or The excess of fair market value at the time of sale over the amount paid per share (option price).

option price

The price at which the employee may purchase the underlying stock. This is also sometimes referred to as the exercise price, grant price, or strike price.

fair market value

The price for which property would sell on the open market between a willing buyer and seller.

vesting

The process by which property becomes transferable, and the employee no longer has a substantial risk of forfeiting, or losing, the property.

Any of the following events can trigger taxable earnings for an employee who receives an employee stock option as compensation for services provided:

The taxpayer receives, or is granted, the option. The taxpayer exercises, or uses, the option. The taxpayer sells the option or the underlying stock.

Where will an employer report income from a nonqualifying disposition from an ISO?

W-2 box 1 (but not 3 or 5)

When do you not have to recognize any compensation from a nonstatutory option?

When the value cannot be determined

ESPPs

a company-run program in which participating employees can purchase company stock at a discounted price

ESPP Qualifying Disposition granted at FMV: Any increase in the value of the stock will be treated as ______________

a long-term capital gain.

options

a type of contract that gives the owner the right, or option, to buy or sell an underlying asset, at a fixed price, on or before a certain date.

Stocks

a type of equity investment in a corporation

Since ISOs do not receive the same favorable tax treatment under AMT that they do under the regular tax system, the taxpayer must ___________________________________

adjust their basis in the stock for AMT purposes.

ESPP look-back provision

allow the plan to base the purchase price of the stock on the price of the shares at either the beginning or end of the offering period, whichever is lower

formula for taxpayer's basis in underlying stock

amount paid for the stock + amount of compensation recognized as income

What are the tax consequences of selling stock as a nonqualifying disposition?

at least a portion of any gain will be taxed as ordinary income.

How is AMT's purpose primarily accomplished?

by limiting certain credits and deductions

A revision to the Tax Code under TCJA enables eligible taxpayers who work for privately held corporations to

elect to defer, for up to five years, the payment of taxes on the value of qualified stock acquired through the exercise of employee stock options and restricted stock units.

ESPP Nonqualifying Disposition: If the holding period requirement was not met, then the amount subject to tax as ordinary income may __________________

exceed the gain on the sale.

In the case of a nonqualifying disposition, what amount is included in ordinary income?

fair market value of the stock on the exercise date (or the vesting date, if later) minus the option price; Any additional gain or loss is treated as a capital gain or loss.

What is the consequence of AMT exemptions on ISO's?

far fewer taxpayers who exercise incentive stock options will be subject to AMT for Tax Years 2018 - 2025.

If an employer issues restricted shares of company stock to an employee, then the employee typically does not have to include the value of the stock in their taxable income until it is

fully vested

ESPP Qualifying Disposition at discount: The amount subject to ordinary income in a qualifying disposition cannot exceed the ________________

gain from the sale of underlying stock.

What are the tax consequences of selling stock as a qualifying disposition?

generally have a long-term capital gain or loss. Any gain will be taxed at the more favorable rate applied to long-term capital gains.

ISOs (aka qualified stock options)

give the employee the option to buy a fixed number of shares at a specified grant price

If a taxpayer has a nonqualifying disposition for an ESPP, they did not meet the _______ and generally will have ___________

holding period requirement; ordinary income

The tax treatment for the sale of stock acquired when a taxpayer exercises an option granted under an ESPP depends on whether the ___________ requirement was satisfied; also ____________ is a factor

holding period; Whether the employee purchased the underlying stock at a discount

When must a taxpayer make a positive AMT adjustment for the year?

if the grant price was less than the fair market value of the stock at the time of purchase

Under the AMT rules, the difference between the fair market value of the stock on the date the ISO was exercised and the price the taxpayer actually paid is considered ______________

income for the year the option is exercised

The purpose of AMT is to make sure

individuals with higher incomes pay at least a minimum amount of federal income tax

When does an ISO holding period begin?

on the day after the employee exercises the option

ESPP Qualifying Disposition at discount: If the plan offered the opportunity to purchase shares of stock at a discount, then the taxpayer will have _______________ from compensation.

ordinary income

ESPP Qualifying Disposition at discount: When computing their basis, the taxpayer adds any amount reported as ________ to the amount paid for the stock.

ordinary income

For the purpose of this course, what is equity?

ownership stake in a company

The ESPPs discussed in this course are all _____

qualified

How are statutory and nonstatutory stock options different in how they can be offered?

statutory options may only be issued to employees of a company; nonstatutory options can be offered to employees and just about any other service provider (eg consultants, contractors, members of board of directors).

nonqualifying disposition (for ISOs) (aka disqualifying disposition)

taxpayer has not met holding period requirement when they sell or otherwise dispose of the stock

ESPP Nonqualifying Disposition: What is the mount of ordinary income?

the amount by which the fair market value at the time of exercise exceeded the option price

For ISO nonqualified dispositions, what is the taxpayer's basis?

the amount paid for the stock, plus any amount included in ordinary income.

ESPP Nonqualifying Disposition: What is the taxpayer's basis?

the amount reported as ordinary income, plus the amount paid for the stock.

In the case of a qualifying disposition, what is the basis of the stock?

the amount the taxpayer paid for their shares

Unlike a qualifying disposition, when a taxpayer sells shares of stock acquired through an ESPP in a nonqualifying disposition, the amount included in ordinary income is not limited to _____________________

the gain from the sale of the stock.

ESPP Qualifying Disposition granted at FMV: If the option price per share was the same as the fair market value of the stock when the option was granted (no discount was available), then the taxpayer's basis is _________________________________

the same as the option price at the time they exercised their option.

when is the date the stock is transferred?

typically the exercise date, or the date the taxpayer purchased their shares

For a nonqualifying disposition of an ISO, how much of a gain is treated as ordinary income from compensation?

up to the amount by which the fair market value at exercise exceeded the option price

Eligible employees must make the election to defer taxation within 30 days after they become

vested

To qualify for the election to defer income when they acquire the stock, the employee must

work for a privately held corporation and receive the stock as part of a qualifying equity grant.