6 employee stock plan mistakes to avoid

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Back to main Resources page Exercise Rules for Stock Options How to Avoid Tax Pain when Exercising Stock Options Stock options are an increasingly popular "benefit" offered to employees, but if you're not carefuland plenty of dotcommers weren't a few years ago-your options can cause you more financial pain than gain.

When should i sell employee stock options how to make sure your options are a profitable exercise: There's another breed of options called Incentive Stock Options ISOs but they are when should i sell employee stock options reserved for high-end execs.

And that means you need to understand some tricky tax rules. You owe absolutely no tax on the options until you choose to exercise the options. The Exercise Price is the market price on the day you choose to cash in your options.

Typically when you receive a stock option grant your shares vest over a set period; 25 percent a year over four years is common. That means that after the first year you could exercise 25 percent of your grant; after two years you could exercise 50 percent etc… At the end of the fourth year all the options would be yours. It's typical to have 10 years from the initial issue date to exercise the options.

And the screwy fact is that even if you own the options for a couple of years, the gain you get on the exercise date the difference between the grant price and the exercise price is going to be taxed as ordinary income. You don't get to opt for the lower capital gains tax rate, which is 15 percent for most folks. Okay I bet an example would help here. Now listen carefully, because here is where so many dotcommers got hammered. And as I mentioned a second ago, you owe tax at your ordinary income tax rate.

What trips up so many folks with NQSOs is that they exercise and continue to hold the stock when should i sell employee stock options they think it is going to go higher, and they figure if they hold for another year they will be able to reduce their tax bill since they will qualify for the long-term capital gains tax rate of either 10 percent or 15 percent. That's simply wrong, wrong, wrong. If you do hold onto the stock you still owe income tax on the gain you got on the date of the exercise.

Only the gains after the exercise date are eligible for the capital gains tax rate. And here's the real problem: Don't think you can call it a wash. So here's your best options option: When you exercise your options I think you should sell immediately. This is known as a cashless transaction.

It guarantees that you "book" the profit. Then you can decide what to do with all that money; put it in a savings account for your when should i sell employee stock options down payment, pay down your credit card debt, or invest it in stocks or mutual funds for the long-term.

Not only does this assure you won't fall into the tax trap, it also forces you to wisely diversify. Look, I hope your company-and its stock-continues to do well, but as I mentioned in the book, no single stock should account for more than five percent of your assets. If you are over reliant on a single stock-be it your employer or not-you are taking on too much risk.

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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:. Refer to Publication , Taxable and Nontaxable Income , for assistance in determining whether you've been granted a statutory or a nonstatutory stock option. 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 Instructions. 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 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. 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 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.

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 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. For specific information and reporting requirements, refer to Publication For you and your family. Individuals abroad and more.

EINs and other information. Get Your Tax Record. Bank Account Direct Pay. Debit or Credit Card. Payment Plan Installment Agreement. Standard mileage and other information. Schedule A Form Application for Automatic Extension of Time. Employer's Quarterly Federal Tax Return. Employee's Withholding Allowance Certificate.

Request for Transcript of Tax Return. Popular For Tax Pros. Apply for Power of Attorney. Apply for an ITIN. Home Tax Topics Topic No.

Topic Number - Stock Options 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. 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.

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. More Tax Topic Categories. Page Last Reviewed or Updated: