Claiming stock options on tax return

If you receive an option to buy stock as payment for your services, you may have income when you receive the option, when you exercise the option, or when you dispose of the option or stock received when you exercise the option. There are two types of stock options:
Options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are statutory stock options . Stock options that are granted neither under an employee stock purchase plan nor an ISO plan are nonstatutory stock options .
Refer to Publication 525, Taxable and Nontaxable Income , for assistance in determining whether you've been granted a statutory or a nonstatutory stock option.
Statutory Stock Options.
If your employer grants you a statutory stock option, you generally don't include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO. For more information, refer to the Form 6251 (PDF). You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition. Refer to Publication 525 for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes.
Incentive Stock Option - After exercising an ISO, you should receive from your employer a Form 3921 (PDF), Exercise of an Incentive Stock Option Under Section 422(b) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income (if applicable) to be reported on your return.
Employee Stock Purchase Plan - After your first transfer or sale of stock acquired by exercising an option granted under an employee stock purchase plan, you should receive from your employer a Form 3922 (PDF), Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income to be reported on your return.
Nonstatutory Stock Options.
If your employer grants you a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined .
Readily Determined Fair Market Value - If an option is actively traded on an established market, you can readily determine the fair market value of the option. Refer to Publication 525 for other circumstances under which you can readily determine the fair market value of an option and the rules to determine when you should report income for an option with a readily determinable fair market value.
Not Readily Determined Fair Market Value - Most nonstatutory options don't have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there's no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525.

» The taxation of stock options.
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The taxation of stock options.
As an incentive strategy, you may provide your employees with the right to acquire shares in your company at a fixed price for a limited period. Normally, the shares will be worth more than the purchase price at the time the employee exercises the option.
For example, you provide one of your key employees with the option to buy 1,000 shares in the company at $5 each. This is the estimated fair market value (FMV) per share at the time the option is granted. When the stock price increases to $10, your employee exercises his option to buy the shares for $5,000. Since their current value is $10,000, he has a profit of $5,000.
How is the benefit taxed?
The income tax consequences of exercising the option depend on whether the company granting the option is a Canadian-controlled private corporation (CCPC), the period of time the employee holds the shares before eventually selling them and whether the employee deals at arm’s - length with the corporation.
If the company is a CCPC, there won’t be any income tax consequences until the employee disposes of the shares, provided the employee is not related to the controlling shareholders of the company. In general, the difference between the FMV of the shares at the time the option was exercised and the option price (i. e., $5 per share in our example) will be taxed as employment income in the year the shares are sold. The employee can claim a deduction from taxable income equal to half this amount, if certain conditions are met. Half of the difference between the ultimate sale price and the FMV of the shares at the date the option was exercised will be reported as a taxable capital gain or allowable capital loss.
Example: In 2013, your company, a CCPC, offered several of its senior employees the option to buy 1,000 shares in the company for $10 each. In 2015, it’s estimated that the value of the stock has doubled. Several of the employees decide to exercise their options. By 2016, the value of the stock has doubled again to $40 per share, and some of the employees decide to sell their shares. Since the company was a CCPC at the time the option was granted, there’s no taxable benefit until the shares are sold in 2016. It’s assumed that the conditions for the 50% deduction are satisfied. The benefit is calculated as follows:
What if the stock declines in value?
In the above numerical example, the value of the stock increased between the time the stock was acquired and the time it was sold. But what would happen if the share value declined to $10 at the time of sale in 2016? In this case, the employee would report a net income inclusion of $5,000 and a $10,000 capital loss ($5,000 allowable capital loss). Unfortunately, while the income inclusion is afforded the same tax treatment as a capital gain, it isn’t actually a capital gain. It’s taxed as employment income. As a result, the capital loss realized in 2016 cannot be used to offset the income inclusion resulting from the taxable benefit.
Anyone in difficult financial circumstances as a result of these rules should contact their local CRA Tax Services office to determine whether special payment arrangements can be made.
Public company stock options.
The rules are different where the company granting the option is a public company. The general rule is that the employee has to report a taxable employment benefit in the year the option is exercised. This benefit is equal to the amount by which the FMV of the shares (at the time the option is exercised) exceeds the option price paid for the shares. When certain conditions are met, a deduction equal to half the taxable benefit is allowed.
For options exercised prior to 4:00 p. m. EST on March 4, 2010, eligible employees of public companies could elect to defer taxation on the resulting taxable employment benefit (subject to an annual vesting limit of $100,000). However, public company options exercised after 4:00 p. m. EST on March 4, 2010 are no longer eligible for the deferral.
Some employees who took advantage of the tax deferral election experienced financial difficulties as a result of a decline in the value of the optioned securities to the point that the value of the securities was less than the deferred tax liability on the underlying stock option benefit. A special election was available so that the tax liability on the deferred stock option benefit would not exceed the proceeds of disposition for the optioned securities (two-thirds of such proceeds for residents of Quebec), provided that the securities were disposed after 2010 and before 2015, and that the election was filed by the due date of your income tax return for the year of the disposition.

Stocks and Taxes: What You Have to Pay, When.
By Bonnie Lee Published December 16, 2010 Features.
If you play the stock market (if you’re no longer shell shocked by the volatility of the past couple of years) you may want to know a little about the taxability of your securities transactions.
Continue Reading Below.
Capital Gains Tax.
Any profit you enjoy from the sale of a stock held for at least a full year is taxed at the long-term capital gains rate, which is lower than the rate applied to your other taxable income. It’s 15% if you are in a 25% or higher tax bracket and only 5% if you are in the 15% or lower tax bracket. Profits from stocks held for less than a year are taxed at your ordinary income tax rate.
Ordinary dividends earned on your stock holdings are taxed at regular income tax rates, not at capital gains rates. However, “qualified dividends” are taxed at a very advantageous capital gains rate of 0% to a maximum of 15%. For dividends to be classified as “qualified” they must be paid by a U. S. corporation or a qualified foreign corporation and the holding period of the stock must be more than 60 days. There are plenty of other exceptions and definitions, so check with your broker or tax advisor to see if the dividends for your stock holdings are “qualified.” Dividends on stock held in a qualified retirement plan are not taxable income.
I believe Congress enacted the lower capital gains rate to drive investment. After all, most tax laws are passed as a form of directing social behaviors. Be sure to follow what happens to the capital gains rate during the course of the next several months. President Obama has thrown out the idea of raising the capital gains tax rate many times, although nothing has happened yet. In fact, at this writing, the talk is that the current rates will remain in effect for the next two years. If that doesn’t happen and as a year-end tax tip, I advise you to sell appreciated stock held more than a year while the lower rates are in effect.
Continue Reading Below.
When determining your profit from a stock sale, it’s important to understand not only the formula, but the meaning of the variables in the formula. Certain circumstances applied to the variables can reduce your tax liability when you sell. Many taxpayers believe they must pay taxes on the full amount of the check they receive from the sale--not true. You can subtract your basis.
The formula is: Sales Proceeds – Basis = Taxable Profit or Deductible Loss.
Sale proceeds can be reduced by commissions paid to the broker.
Basis is the cost of the stock plus any reinvested dividends and commissions paid for acquisition. If you inherited the stock, the basis is the fair-market value of the stock on the date of the decedent’s death or the alternate valuation date. If the stock was received as a gift, the basis is the lower of the fair-market value or the basis of the donor at the time the gift was made.
Many investors benefit from selling a stock in a losing position to offset a gain, then turn around and buy the stock right back.
However, the IRS will not allow an investor to claim a capital loss if you sell a stock and buy it back within 30 days. The “wash rule” prevents you from claiming a loss on a sale of stock if you buy replacement stock within the 30 days before or after the sale and you will lose the offset.
One of the big limitations in stock investing is the amount of losses you are allowed to deduct on your tax return. If you sell stocks at a loss, you may deduct only $3,000 per year; the remainder of the loss is carried forward to future years. You may apply capital losses against capital gains in the current and future years to net out the overall profit or loss.
Deductible Investment Expenses.
A tax deduction often overlooked by investors is the cost of management fees paid to brokers, usually for management of mutual fund accounts or for advisory services. You may deduct these fees as an investment expense on Schedule A of your tax return. Some brokerage 1099s or year-end statements will state the total for the year, but many do not. You may have to call your broker to find out how much you paid.
Audit Taxpayers oftentimes forget about a stock sale when compiling their income tax return, which results in the IRS sending a CP-2000 letter. The letter is about 12-pages long and somewhere in the middle is a listing of omitted items and a calculation of the tax liability on those items. If you receive one showing an omitted stock sale, don’t just pay the tax bill. The IRS only knows about the stock sale; they have no clue as to what your basis in the stock is. Remember the formula earlier? You may actually have taken a loss on the stock and that means no tax liability whatsoever. In fact, you may be entitled to a refund. So call the phone number on the front of the letter and let them know that you will amend that tax return.
However, beginning Jan. 1, 2011 as a part of the Emergency Economic Stabilization Act of 2008, brokerage firms will be required to report the cost basis and gain/loss information to the IRS on their form 1099, which will be issued in 2012. This will streamline the tax preparation process considerably and result in accurate CP-2000 letters being sent to taxpayers. It will also cut down on the number of amended tax returns that need to be filed as a result of omitting stock sales.
Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know,” available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook.
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Claiming stock options on tax return.
On-screen help is available on a PC, laptop or the TurboTax mobile app. Refer to Publication for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes. Prices subject to change without notice. If the market turns on you after you have exercised your options and the current value of your stock is now less than what you paid, you could still be subject to the Alternative Minimum Tax. The Bottom Line Taxes on options are incredibly complex, but it is imperative that investors build a strong familiarity with the rules governing these derivative instruments. Often what looks too good to be true catches the attention of the IRS and could subject you to paying back taxes and penalties.
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