Call toll-free using our international dialing instructions. Toll-free Outside U. How you manage your stock options will determine whether you make money or lose money. In some cases, the losses can be substantial. Here, we'll explore how stock options work, including exercise methods and taxes. Helpful information for investors who have received stock options from their employers. Making the right decisions about stock options can put money in your pocket.
Making the wrong decisions could cost you money—in some cases, a lot of money. A stock option grant gives you the right, but not the obligation, to buy a certain number of shares example your employer's stock at a set price within a certain timeframe. Conditions that apply to your options are spelled out in your grant agreement.
It will tell you: The grant date is when you've officially been granted your options. This is essential to help you and the company keep track of important dates like vesting schedules and exercise periods see below.
How many and what kind of options—incentive stock options ISOs or non-qualified stock options NQSOs —you have been granted. The strike exercise price for the grant. The strike price is the amount you'll pay for each share of stock when you stock your options.
Exercising means that you use your options to buy shares of company stock at the strike price. The strike price for each grant won't change even if the price of the stock changes. Generally, you must hold options for a period of time before exercising them. This is the amount of time you have to exercise your options once they vest. In most cases, you'll have 10 years from the date of grant before your options expire.
The tax treatment of incentive stock options and non-qualified stock options is different. Generally, ISOs are eligible for special tax treatment and NQSOs aren't. To options for special tax treatment, you must hold shares from an ISO exercise for longer than: Two years from the grant date and One year from the exercise date. If you meet the holding period requirements, the ISO exercise is tax free for ordinary income tax purposes.
When you later sell the shares, the transaction is taxed at the long-term capital gains tax rate, which is more favorable than regular income tax rates. Your cost basis is equal to your strike price. If you don't meet the holding requirements, you'll disqualify your ISOs and you will owe regular income tax in the year of the disqualifying disposition the year you sell. The incentive owed will be based on the lesser of the spread difference between the strike price and the market price of the shares at the time of exercise or disposition.
A disqualifying disposition below the original market value at the time of exercise would generate a capital loss with no ordinary income tax.
Exercising ISOs also may trigger alternative minimum tax AMT. Although the ISO spread at the time of exercise is not taxable for ordinary purposes, it's included on your income tax return as an AMT adjustment.
If AMT applies, you may owe additional income tax in the year of exercise. A disqualifying disposition in the same year of exercise eliminates the AMT issue, but if a disqualifying disposition occurs in a year subsequent to exercise you could be faced with the worst of both worlds—AMT in the year of exercise and ordinary income tax in the year of the disqualifying disposition. You should think of any AMT you might owe as a "prepaid" tax. Generally, if you hold the ISO stock for the required period of time in a qualifying disposition, the sale may generate an AMT credit.
The important thing to remember is that you have a dual cost basis—the strike price at the time of exercise is your cost basis for ordinary tax capital gain purposes and the market price at the time of exercise is your cost basis for AMT purposes. Your tax preparer can figure out the rest, as long as you keep good records. The special tax treatment and holding periods don't apply to NQSOs. When you exercise NQSOs, you'll owe regular income tax in the year of exercise based on the spread at the time you exercise your options.
NQSOs are also subject to income and payroll FICA tax withholding at the time of exercise. When you exercise options, you buy shares of company stock at the strike price.
If the strike price is lower options the market price of the stock, the options are in the money. If the strike price is higher than the market price, the options are out of the money, incentive under water. Generally, you can choose from three exercise methods check your specific stock option plan: You must provide the money to pay for the exercise plus any transaction fees and applicable withholding taxes.
You use your options to buy shares of stock, which you simultaneously sell in order options pay the exercise cost, transaction fees and any withholding taxes due at exercise. You may sell all the shares and pocket any remaining cash or sell just enough shares to pay everything and keep the remaining shares in a brokerage account.
Some employers let you exercise your options and use company stock that you already own to incentive the exercise cost. You may still owe transaction fees and taxes. Before you exercise employer stock options, talk to a tax advisor or financial advisor. You need to understand how the exercise will affect your tax liability, and you may have to pay estimated taxes to avoid underpayment penalties for the year.
Important Disclosures The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment stock tax advice. Each investor needs to stock a security transaction for his or her own particular situation.
Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed. Examples provided are for illustrative or "informational" purposes only and not intended to be reflective of results you can expect to achieve. Spiegelman specializes in personal financial planning, including income tax, estate tax, retirement, cash flow, net worth, compensatory stock options, employee plans, investments and portfolio planning.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options before considering any option transaction.
Diversification strategies do not assure a profit and do not protect against losses in declining markets. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions.
Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you should expect to attain.
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