TAX FACTS
by
Santoro & Sinnamon
Certified Public Accountants
51 Mill Street
Wolfeboro NH 03894
603-569-5255
Understanding Stock Options
Stock options received from a corporation can be a complicated topic. This article is a simplified summary version to provide a basic understanding of how stock options work when offered by an employer to an employee.
Corporate stock and partnership interests can be offered to employees in a variety of ways. An employer can grant shares of stock to an employee or can grants rights to an employee to buy shares of stock. Each option has its own tax consequences to the employee and the employer. This article will be addressing the later, where an employer grants rights to an employee to buy shares of stock. The grant of rights can be down one of two ways: “Incentive Stock Options” or “Nonqualified Stock Options”.
Incentive stock options are a right to buy equity in the corporation at a certain price. A corporation issues an option to purchase stock at a price which is usually equal to (but never less than) the fair market value of the stock on the date the option is granted. The employee then exercises the option to purchase the shares at the specified price at a future date in time. Once the option is exercised, the employee then sells the stock at a future date, hopefully at a gain. The employee pays a capital gain tax on any gain generated between the sale price of the stock and the purchase at the exercised option price.
Nonqualified stock options are also a right to buy equity in a corporation but they do not meet all the requirements of incentive stock options. In this case the corporation usually grants an option to purchase stock at a price that is lower than the fair market value of the stock. When the employee exercises the option to purchase the stock at their granted option price, they have taxable income to the extent that the fair market value of the stock exceeds the option price (also known as the strike price). This income is usually included in the employees W2 and taxed at their ordinary income tax rate. The employee then can sell the stock and then receives a capital gain or loss on the difference between the fair market value of the stock on date of purchase vs the fair market value on date of sale. Typically the stock is sold immediately after purchase and there very little gain or loss to recognize on the sale.
There a significant amount of rules and regulations surrounding stock options. I recommend any employee being offered options to purchase employer stock consult a tax advisor to assist in understanding the tax consequences of the transaction.
This article has been provided to give you a general overview, you should always consult a tax advisor as individual circumstances may vary. Should you have any questions, please contact Lorena Sinnamon, CPA, at Santoro & Sinnamon Certified Public Accountants at one of our locations: Commerce Corner Building, 43 South Road, Suite 200, Deerfield, NH 03037 or Bayside Village Building, 51 Mill Street, Wolfeboro NH 03894 1-800-220-5521, lsinnamon@nh-cpas.com, or visit us at www.nh-cpas.com and sign up for our newsletter.