Stock Options: Statutory Stock Options - ISOs & ESPPs (Part I)
📈 Stock Option: What Is It?
The right of an employee, but not an obligation, to buy shares of their employing company stock at a predetermined price.
📈 Statutory vs. Nonstatutory: What Is The Difference?
Statutory Stock Options receive more favorable treatment thru special statutes in the tax code.
✅ Income reported when stock is sold
✅ No FICA
✅ No federal income tax W/H
✅ Capital gains treatment on all income if the holding period is met
🔁Conclusion:
Statutory Stock Options > Nonstatutory Stock Options
What types are there?
1️⃣Incentive stock options (ISOs)
🟠Disqualifying DIsposition ISO
🟠Qualifying Disposition ISO
2️⃣Employee Stock Purchase Plan (ESPPs)
🟠Disqualifying disposition of qualified ESPP
🟠Qualifying disposition of qualified ESPP
🟠Nonqualified ESPP
3️⃣Nonqualified Stock Options (NQSOs) - Part II
4️⃣Restricted Stock Units (RSUs) - Part II
1️⃣ Incentive Stock Options (ISOs)
Basics
Only employees are eligible
Vesting usually 2-5 years
Options expire at the end of 10 years
Max $100K of value exercisable in one year (determined on the grant date)
Only type with an AMT disconnect
🤔 Did you know that the value of ISOs is not deductible by the issuing company if sold on qualifying disposition.
ISOs Example #1
Tim C works at Apple.
Tim C receives the option to buy 1,000 shares of Apple at $50 per share on March 1, 2020.
Apple stock is worth $40/share on March 1, 2020
After his 3-year vesting schedule, Apple stock is worth $150.
Tim decides to exercise his option to purchase 1,000 shares.
🧮 Cost basis
Qualified disposition✅: exercise price
Disqualified disposition ❌(gain): exercise price plus ordinary income included in W2
Disqualified disposition ❌ (loss): exercise price
🧩Documents to request (i.e. the puzzle pieces🧩 )
Option agreement
Confirmation of Exercise
Form 3921 (2010+)
Form W2
Form 1099-B (maybe)*
ISO Tax Treatment - Disqualifying Disposition ❌
Holding period not met
Immediate taxation of bargain element (ordinary)
Income reportable in Box 1 of W2
Not subject to FICA or FITW
Not required to notate on Box 14 of W2
No AMT adjustment
📃 ISO Sample Forms 📃
Form 3921
W2 (Disqualifying❌)
Option Confirmation (Disqualifying ❌)
*Quirky 1099-B Rule
🚨There might not be a 1099-B (employers can elect out of issuing under Rev Proc 2002-50) In this case, all the income is reported on Form W2.
1099B (Disqualifying❌)
🚨🚨🚨
Starting in 2014, brokers are prohibited from adding the compensation component to the cost basis, thereby understating the total cost and overstating the gain on the sale of the stock on Form 1099-B (Treasury Decision 9616)
This makes the likelihood of novice tax preparers/self-preparers overstating the gain very, very high. 😱
🚨🚨🚨
ISO Tax Treatment - Qualifying Disposition ✅
🌸Regular Tax
No tax reporting for regular tax purposes when ISO is exercised.
Income is reported when stock is sold.
😵Alternative Minimum Tax
The bargain element is a positive AMT adjustment when exercised
The bargain element is a negative AMT adjustment when sold
W2 (Qualifying ✅)
Option Confirmation (Qualifying ✅)
Form 3921 (Qualifying ✅)
😵Alternative Minimum Tax (Qualifying ✅)
📅 Is there an optimal time to exercise an option?
🅰️Yes! January, February or March. This will allow the taxpayer to hold the shares 1 year before having to pay any 😵Alternative Minimum Tax liability on their tax return.
Holding the shares for one year will not trigger ordinary income compensation.
2️⃣ Employee Stock Purchase Plan (ESPPs)
How they work
The employer withholds funds from employees (Offering period)
At the end of the offering period, the employee chooses:
purchase stock or receive funds back
It may not be discriminatory
May allow employees to purchase stock at a 15% discount
Maximum of $25,000 per year
🧮 Cost basis
Qualified disposition: purchase price plus ordinary income included in W-2
Disqualified disposition: market price at purchase
🧩ESPP Documents to request (i.e. the puzzle pieces🧩 )
Confirmation of Exercise
Form 3922
Form W2
Form 1099-B
Stock Plan Transaction Supplemental Information
ESPP Tax Treatment - Disqualifying Disposition ❌ of Qualified ESPP
No income is reported when stock is purchased even if discounted.
Income reported when stock is sold
Holding period not met
Bargain element reportable in Box 1 of W2
Not subject to FICA or FITW
No AMT adjustment
ESPPs Example #1 (Disqualifying Disposition❌)
Frankie works at FaceBook.
Frankie has $100/pay x 13 weeks
Offering period Jan 1, 2020 - June 30, 2020.
FMV Jan 1 = $20 ($20 x 85% = $17)
FMV June 30 = $25 ($25 x 85% = $21.25)
15% discount
Lookback provision available
Same day sale (this makes it disqualifying)
Purchase price?
$17/share
Shares purchased?
$1,300/$17 = 76 shares
Bargain element?
($25 - $17) x 76 shares = $608
Discount?
($20 - $17) x 76 shares = $228
Form 3922
Stock Plan Transaction Supplemental Information
Result of ESPP Example #1 Disqualifying Disposition ❌
🚨The "adjusted amount" is included in W2 box if a disqualifying disposition❌ :
Box 1 = Wages + $608
Box 3 = Wages
Box 5 = Wages
Box 14 = Might notate bargain amount, but not required.
ESPP Tax Treatment - Qualifying Disposition✅ of Qualified ESPP
Discount income reported when stock is sold
Holding period met
Discount reportable in Box 1 of W2 (not to be confused with bargain element)
Not subject to FICA or FITW
No AMT adjustment
ESPPs Example #2 (Qualifying Disposition✅)
Frankie works at FaceBook.
Frankie has $100/pay x 13 weeks
Offering period Jan 1, 2020 - June 30, 2020.
FMV Jan 1 = $20 ($20 x 85% = $17)
FMV June 30 = $25 ($25 x 85% = $21.25)
15% discount
Lookback provision available
Sells stock in 2023(this makes it qualifying)
Stock is sold for $27/share
ESPP Result - Qualifying Disposition✅
Income reported when stock is sold:
-($20-$17) x 76 shares = $228 ordinary income (the discount)
-($27-$20) x 76 shares= $532 LT capitan gain
🚨🚨Be sure not to confuse the bargain element and discount
In conclusion
Income from Statutory or Qualified Options reported when sold.
Income not subject to FICA
ISOs less common than NQSOs
Qualified ESPP more common than Nonqualified ESPP