Stock options give you the right to buy shares of a particular stock at a specific price. The tricky part about reporting stock options on your taxes is that there are many different types of options, with varying tax implications.
Taxes on stock options
The underlying principle behind the taxation of stock options is that if you receive income, you will pay tax. Whether that income is considered a capital gain or ordinary income can affect how much tax you owe when you exercise your stock options.
There are two main types of stock options:
- Employer stock options
- Open market stock options
Receiving an employer stock option
The two main types of stock options you might receive from your employer are:
- Incentive stock options (also known as statutory or qualified options, or ISOs) and
- Non-qualified stock options (aka non-statutory options or NSOs)
These employer stock options are often awarded at a discount or a fixed price to buy stock in the company. While both types of options are often used as bonus or reward payments to employees, they carry different tax implications.
The good news is that regardless of the type of option you are awarded, you usually won't face any tax consequences at the time you receive the option.
No matter how many statutory or non-statutory stock options you receive, you typically don't have to report them when you file your taxes until you exercise those options, unless the option is actively traded on an established market or its value can be readily determined. This exception is rare but does happen at times.
Exercising an option
When you exercise an option, you agree to pay the price specified by the option for shares of stock, also called the award, strike, or exercise price.
For example, if you exercise the option to buy 100 shares of IBM stock at $150/share, at the time of exercise you'll effectively exchange your option for 100 shares of IBM stock, and you'll no longer have the right to buy additional IBM shares at $150/share.
- When you exercise an incentive stock option (ISO), there are generally no tax consequences, although you will have to use Form 6251 to determine if you owe any Alternative Minimum Tax (AMT).
- However, when you exercise a non-statutory stock option (NSO), you're liable for ordinary income tax on the difference between the price you paid for the stock and the current fair market value.
If you exercise a non-statutory option for IBM at $150/share and the current market value is $160/share, you'll pay tax on the $10/share difference ($160 - $150 = $10).
For example:
- 100 shares x $150 (award price)/share = $15,000
- 100 shares x $160 (current market value)/share = $16,000
- $16,000 - $15,000 = $1,000 taxable income
Since you'll have to exercise your option through your employer, your employer will usually report the amount of your income on line 1 of your Form W-2 as ordinary wages or salary and the income will be included when you file your tax return.
Selling stock
When you sell stock you've acquired via the exercise of any type of option, you might face additional taxes.
- Just as if you bought a stock in the open market, if you acquire a stock by exercising an option and then sell it at a higher price, you have a taxable gain.
- If you satisfy the holding period requirement, by either keeping the stock for 1 year after exercising the option or 2 years after the grant date of the option, you will report a long-term capital gain, which is usually taxed at a lower rate.
- If you don't meet the holding period requirement, your gain is considered short-term and taxable as ordinary income.
You should report a long-term gain on Schedule D of Form 1040. A short-term gain will typically appear in box 1 of your W-2 as ordinary income, and you should file it as wages on Form 1040.
Open market options
If you buy or sell a stock option in the open market, the taxation rules are similar to options you receive from an employer. When you buy an open-market option, you're not responsible for reporting any information on your tax return.
However, when you sell an option—or the stock you acquired by exercising the option—you must report the profit or loss on Schedule D of your Form 1040.
- If you've held the stock or option for one year or less, your sale will result in a short-term gain or loss, which will either add to or reduce your ordinary income.
- Options sold after a one year or longer holding period are considered long-term capital gains or losses.
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FAQs
When you buy an open-market option, you're not responsible for reporting any information on your tax return. However, when you sell an option—or the stock you acquired by exercising the option—you must report the profit or loss on Schedule D of your Form 1040.
Do you get a 1099 for stock options? ›
If you sold stock, you'll receive Form 1099-B and the Supplemental Information form during the tax season. The information on your 1099-B is reported to the IRS, but the Supplemental Information form includes adjustments to a capital gain or loss necessary to avoid overpaying taxes.
Do I have to report taxes on options trading? ›
If you're trading options, chances are you've triggered some taxable events that must be reported to the IRS. While many options profits will be classified as short-term capital gains, the method for calculating gains or losses will vary by strategy and holding period.
How are incentive stock options reported on W-2? ›
Income is reported on Form W-2 only with a disqualifying disposition. When you sell your ISO stock, in addition to any ordinary income reported, you also need to report any gain or loss from the sale. Accurately reporting your gain or loss will help you from overpaying taxes.
Do you pay taxes twice on stock options? ›
Stock options are typically taxed at two points in time: first when they are exercised (purchased) and again when they're sold. You can unlock certain tax advantages by learning the differences between ISOs and NSOs.
How do I record stock options on my tax return? ›
However, when you sell an option—or the stock you acquired by exercising the option—you must report the profit or loss on Schedule D of your Form 1040. If you've held the stock or option for one year or less, your sale will result in a short-term gain or loss, which will either add to or reduce your ordinary income.
How do I report employee stock options on a tax return? ›
You will receive a Form 1099-B in the year you sell the stock units. The form reports any capital gain or loss resulting from the transaction on your tax return. You should review your investment records to verify the cost basis amount on Form 1099-B.
How are stock options reported to IRS? ›
Statutory stock options
You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.
How do I report option trading income? ›
Reporting Of F&O Gains And Losses
If F&O trading is conducted frequently and with the intention of earning a profit, gains and losses are treated as business income. Conversely, if F&O trading is done infrequently and not as a regular business activity, gains and losses are treated as capital gains.
Do you have to declare stock options? ›
The security options benefit is taxable to you as employment income in the year you exercise the options, and is reported to you on your T4 tax slip, along with your salary, bonus and other sources of employment income. The security options benefit is normally added to the adjusted cost base (ACB) of your shares.
ISOs aren't taxed when granted, upon vesting or when exercised. Taxes are deferred until shares are sold, and if you meet certain holding requirements, ISOs are subject only to capital gains taxes.
What is the IRS form for incentive stock options? ›
Form 3921 is an IRS form that must be filed by a company when an employee has exercised an incentive stock option (ISO) in the last tax year.
How much are stock options taxed? ›
When you exercise nonqualified stock options, your employer will most likely withhold a flat 22% for federal income taxes. However, you might be under-withheld if you're in the 32%, 35%, or 37% tax bracket. Stock options can be advantageous but can also create unexpected tax consequences.
How to calculate income tax on options trading? ›
If you are trading in Futures and Options, you should get your accounts audited if your turnover is more than ₹10 crore. You can also apply a presumptive taxation scheme if your turnover does not exceed ₹2 crore and declare that your taxable income is at 6% of the total Futures and Options turnover.
How do you pay taxes on options trading? ›
Non-equity options taxation
No matter how long you've held the position, Internal Revenue Code section 1256 requires options in this category to be taxed as follows: 60% of the gain or loss is taxed at the long-term capital tax rates. 40% of the gain or loss is taxed at the short-term capital tax rates.
What is the 60 40 tax rule? ›
Futures, forex, and options
Section 1256 contracts get special tax treatment of 60/40. This means that positions held for any amount of time will receive 60% long-term capital gains treatment and 40% short-term capital gains treatment.
Are stock options reported as income? ›
You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income.
Do you get a 1099 for stocks? ›
If you sold stock, bonds or other securities through a broker or had a barter exchange transaction (exchanged property or services rather than paying cash), you will likely receive a Form 1099-B. Regardless of whether you had a gain, loss, or broke even, you must report these transactions on your tax return.
Do you pay payroll taxes on stock options? ›
Employees do not owe federal income taxes when the option is granted or when they exercise the option. Instead, they pay taxes when they sell the stock. However, exercising an ISO produces an adjustment for purposes of the alternative minimum tax unless the stock is sold in the same year that the option is exercised.
