Stock Options & Cost Basis Tax Treatment
Correctly calculating the capital gain on stock acquired from exercise of stock options requires identifying the factors affecting cost basis. There are two types of stock options, and the basis calculation for one of these is affected by when the acquired stock is sold. In addition, there are two income tax systems that may cause a different basis to exist under each. Finally, the tax treatment of cost basis as either short term or long term is determined by the holding period for the stock.
Other People Are Reading
-
ISOs
-
If the stock acquired from the exercise of incentive stock options (ISOs) is held for a qualified period, the cost basis is only the exercise price. A qualified holding period is more than one year after exercise of the ISOs and more than two years after grant of the ISOs. If either of these conditions is not met, an additional value---the "bargain element"---is added to basis upon sale of the stock. The bargain element is the amount by which the market value of stock on the exercise date exceeds the option exercise cost.
A different basis is calculated under the alternative minimum tax (AMT) when stock is acquired with ISOs and not sold in the exercise year. The AMT stock basis is the cost to exercise the ISOs plus the bargain element. Consequently, stock acquired from exercise of ISOs has a different AMT cost basis than the cost basis under regular income tax.
Non-Qualified Options
-
For non-qualified stock options, basis is the exercise price plus the bargain element. There is no separate calculation of cost basis under AMT for non-qualified options.
-
Two Basis Amounts
-
The cost basis for calculating the taxable capital gain or loss is the exercise price plus any bargain element added. For non-qualified options, the bargain element is added to basis in the year of exercise. For ISOs, the bargain element is added to basis in the year of sale if the stock was not held for the qualified holding period.
For ISOs, there is a different gain under AMT than under the regular income tax. There can be a gain under the regular tax system and a loss under AMT. The dollar limit on tax deduction of a capital loss in a single year applies to both AMT and regular income tax.
Short-Term
-
Stock sold in one year or less after exercise is a short-term capital gain. The cost basis for both non-qualified stock options and ISOs is the exercise price plus the bargain element. For stock acquired by exercise of ISOs, a different cost basis will exist if the sale occurs in the calendar year after exercise. This is because an AMT adjustment was made in the exercise year.
Long-Term
-
Stock sold more than one year after the exercise date is a long-term capital gain. The cost basis for non-qualified stock options is the exercise price plus the bargain element.
If the stock was acquired with the exercise of ISOs and sold before the passage of two years from the ISO grant date, the cost basis is the bargain element added to the option price. The sale is still long-term but the capital gain does not include the bargain element.
If both of the ISO holding period requirements are met for a qualified transaction, the cost basis is only the price paid to exercise the option. The entire long-term capital gain tax treatment is the difference between the sale proceeds and the exercise price.
-
References
- Photo Credit money 3 image by Fyerne from Fotolia.com
