How to Account for Stock Option Issuance Through Payroll
Accounting for stock options through payroll can be tricky. It is important to know the different types of stock options -- incentive stock options and non-qualified stock options, or ISOs and NQSOs, respectively -- and what type of stock options have been granted to the employee. Additionally, you must fully understand the procedure for accounting for each type as the tax treatment of each varies dramatically, for both the employer and the employee, and requires attention to detail to be done accurately.
Other People Are Reading
Instructions
-
-
1
Identify the type of options granted to the employee. Incentive stock options (ISOs or qualified stock options) are a special type of employee stock option that has certain tax benefits and can be granted to an employee subject to strict employment restrictions. Non-qualified stock options do not qualify for the special treatment afforded to incentive stock options and are instead reported through payroll as ordinary compensation to the employee upon issuance and exercise.
-
2
Determine the amount of income (and deduction) that should be reported. At time of issue, NQSOs are not reported as income unless their value is readily determinable. If the value of the NQSOs is readily determinable, then report income for the employee in the amount of their current value and withhold related income and employment taxes for payroll purposes. Reciprocally, the employer may deduct this for tax purposes at the time of grant.
Additionally, the compensation element of NQSOs -- calculated as the difference between the exercise price and the market price on the exercise date -- is taxable upon exercise and income should be reported and payroll taxes withheld accordingly as if this amount was paid to the employee in cash. Notably, the compensation element can be deducted by the employer in the period they are exercised.
-
-
3
Keep records of the options' value when granted, if any, and value at exercise date in case it is needed for future reference. ISOs have several employment restrictions, but have the important tax attribute of not being reported as income to the employee at time of issue or time of exercise. Thus, in certain ways ISOs may be simpler to administrate for payroll purposes, but if the employee is terminated or resigns the options may revert to NQSO status and their value as of grant date will be needed for accurate reporting of payroll.
-
4
Report the employee income for tax purposes. Indicate taxable income from an exercise of non-qualified stock options in box 12 of the Form W-2 using the code "V." The compensation element will also be included in boxes 1, 3 (if applicable) and 5, but should also be reported separately in box 12 to clearly indicate the amount of compensation arising from an NQSO exercise. This will serve as substantiation for the corresponding deduction for compensation expense on the employer's books and tax return.
-
1
References
- Photo Credit Comstock/Comstock/Getty Images
