Taxes When Cashing Stock Options
To coordinate a solid investment strategy, you must study how basic tax law applies to every major asset class. Stock options present complicated tax ramifications, because these vehicles combine employee compensation alongside an investment component. Before estimating your total tax bill, it is critical that you first understand how employee stock options are actually structured. From there, you can make informed trading decisions.
Other People Are Reading
-
Identification
-
Employee stock option plans enable you to purchase company stock at a set strike price over a certain time frame. You will exercise employee stock options to buy stock when the corporation's share price in the market exceeds your strike price. For example, you may be granted stock options on Corporation Z that feature a strike price of $50. You may consider exercising stock options -- if Corporation Z were actually trading for $75 in the stock market.
Timing
-
With stock options, you will not owe taxes at the time the options are granted. Tax considerations actually come into play when you exercise options. After exercising stock options to buy shares, you are likely to owe ordinary income taxes. You will owe taxes on realized capital gains if you opt to sell company stock for a profit at a later date.
-
Ordinary Income Taxes
-
When exercising employee stock options, the difference between your strike price and stock market value of the company stock will be treated as ordinary income. Using Corporation Z as an example, you went on to exercise options to buy stock at the $50 strike price at a time when Corporation Z traded for $75 in the stock market. You would then owe taxes on $25 worth of ordinary income for each share of stock. As of 2010, ordinary income is taxed at 10, 15, 25, 28, 33 and 35 percent rates depending on the amount.
Capital Gains Taxes
-
Capital gains taxes feature a dual tax structure, which varies according to your holding period. Short-term capital gains are taxed at ordinary income rates. Long-term capital gains, however, are either tax-free or taxed at maximum 15 percent rates. For long-term capital gains, you must hold shares of company stock for more than one year after you opt to exercise options. When calculating capital gains, you only take stock market values into consideration. On Corporation Z, you exercised options with a strike price to purchase shares for $50, while Corporation Z actually traded for $75. After two years, Corporation Z appreciates to $110 per share, before you sell off your position. You would then owe taxes on $35 ($110 - $75) worth of long-term capital gains.
-
