New York State Tax

Employee Stock Options and Tax

What are Employee Stock Options?

The stock option itself is the right to purchase stock shares at the price specified on the option. Employee stock options are options to purchase stock in the company that employs a person. There are two kinds of employee stock options. The kind that generally ends up in the hands of upper management are qualified ISOs - Incentive Stock Options. The second kind are nonqualified options - ESOs. Both have expiration dates. After that date they are worthless.

Nonqualified Stock Options

These options are transferrable to children or to charities, if approved by the company, and may be granted at a discount to the stock's current market value. The moment they are exercised, the difference between the option price, or strike price, and the current market price of the stock becomes ordinary income for tax purposes.

If the option is for 100 shares at $50 per share and the option is exercised when the stock reaches $100 per share, then $5,000 must be added immediately to all other ordinary income. Of course, if the stock is available to the employee and the employee chooses to sell it immediately, the $5,000 - less brokerage costs - does actually become income.

If the stock is held to see if it will appreciate more and the stock reaches $150 per share, then that additional $5,000 profit becomes either short-term or long-term capital gains. The gain is short-term if the stock is held less than one year. The flip side of this coin is when the stock is held as an investment but goes down in value. The offset of capital loss may not cover the amount added to ordinary income and that income is still taxable.

Incentive Stock Options

ISOs must be granted at the current market value of the stock. The only transfer permitted is by a will if the employee holding the options dies. The limit on ISOs is $100,000 worth of options that can be exercised in one year.

If the stock is not held for a specified holding period, the option reverts to a nonqualified option and assumes all the tax rules of that type of option. If the stock is held through the holding period, the difference between the option price and the exercised price - spread - is a preference item when calculating the alternative minimum tax and increases the taxable income for that purpose.

Methods of Exercising

Paying With Cash
An employee gives their employer the cash necessary to buy the stock at the option price and they are issued stock certificates in return.

Swapping Stock
If shares of stock are already held by the employee, they may wish to exchange the number of shares necessary to obtain shares matching the option price. If the stock's price is $100 and the option price is $50 and the employee has an option for 100 shares, it would only take 50 owned shares to obtain 100 new certificates.

Working with a Broker
An employee might use their stock options as collateral and buy the stock through a stock broker. If the employee does not wish to keep any of the stock, all the shares are purchased and immediately sold with the residue cash going to the employee. If the employee wishes to keep the residue shares, all the shares are purchased and only enough shares are immediately sold to pay the broker.

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