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.
How to report stock options on tax return? ›
You must report all 1099-B transactions on Schedule D (Form 1040), Capital Gains and Losses and you may need to use Form 8949, Sales and Other Dispositions of Capital Assets. This is true even if there's no net capital gain subject to tax. You must first determine if you meet the holding period.
How are employee stock options reported? ›
Form 3922. Form 3922 is issued for employee stock options you purchased but do not sell. Since you have not sold the stock, the holding period requirements have not been determined. Therefore, the employer does not include compensation income on your Form W-2 as ordinary income.
How do I report option trading income? ›
Reporting Of F&O Gains And Losses
Gains and losses from F&O trading are categorized as either business income or capital gains based on the frequency and intention of trading. If F&O trading is conducted frequently and with the intention of earning a profit, gains and losses are treated as business income.
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 stock options count 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.
What are the tax rules for options? ›
Taxation here is relatively straightforward. The IRS applies what is known as the 60/40 rule to all non-equity options, meaning that all gains and losses are treated as: Long-Term: 60% of the trade is taxed as a long-term capital gain or loss. Short-Term: 40% of the trade is taxed as a short-term capital gain or loss.
How to report stocks on a tax return? ›
Whether you show a profit or a loss, you'll report stock sales on IRS Form 8949. This is the tax form used for reporting sales or exchanges of any capital assets not reported elsewhere. The information about stock sales needed on your Form 8949 should come from a Form 1099-B issued by the brokerage you're using.
How do you record employee stock options? ›
When an employee exercises stock options, you'll credit Common Stock for the number of shares x par value, debit Cash for the number of shares x the exercise price, then debit Additional Paid-In Capital for the difference, representing the increase in value of the shares during the service period.
Do I need to report form 3921 on my tax return? ›
Form 3921 Exercise of an Incentive Stock Option Under Section 422(b), is for informational purposes only and should be kept with your records. It does not need to be entered into your return unless you still hold the stock at year end (if you do, see the previous information regarding Alternative Minimum Tax (AMT)).
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.
Do I need income proof for options trading? ›
We'll need income proof to activate your account. You can upload ONE of the following documents: 1. Last 6 month's bank statement with transactions over ₹20,000.
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 to report option trade on 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 are stock options reported on W-2? ›
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.
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.
Are stock options reported on W-2? ›
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.
Can you write off worthless stock options? ›
Bottom line. If you have a worthless asset, you can claim your tax write-off and reduce your taxable income. But it's important that you follow the IRS procedures, because your brokerage may not report your loss on worthless securities that remain in your account if you can't dispose of them.
