Employees granted stock purchase options or restricted stock may owe income tax at the time of grant, when stock is received, and when stock is sold. There are two types of options: regular stock options and incentive stock options (ISOs). Although each has distinctive tax features, in both cases the acquired stock has no restriction regarding when it may be sold. Restricted stock units (RSUs) do embody this restriction and are taxed differently than either type of option.
Exercising Regular Stock Options
Upon the exercise of a regular stock option, tax is assessed on the “bargain element,” which is the difference between the option exercise price and the market value of the acquired stock.
Exercising Incentive Stock Options (ISOs)
When exercising the type of option known as Incentive Stock Options (ISOs), the bargain element is not added to taxable income upon exercise unless stock is sold. Stock sold upon exercising ISOs is treated just like regular options.
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Grant of Restricted Stock Units (RSUs)
An employee chooses whether to pay tax on the stock value of RSUs at the grant date or wait to pay tax on the stock value at the future date that restrictions lapse.
Selling Stock of Regular Options
Capital gain tax is assessed on the difference between the sale proceeds and the cost basis. The cost basis is the option exercise price plus the bargain element taxed as compensation in the exercise year.
Selling Stock of ISOs
The bargain element for ISO-acquired stock is taxed as compensation in the year stock is sold if this occurs less than one year after the exercise date and less then two years after the grant date. If both qualifications are met, the bargain element is not taxed as compensation and the difference between sale proceeds and the option exercise price is capital gain.
Selling Stock of RSUs
There is a capital gain for stock sold after restrictions lapse. The holding period begins with the date an employee elects tax assessment—the grant date or the date when restrictions lapse.
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