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Capital Gains and Losses
Questions and comments about tax rules for buying and selling stocks, mutual funds, real estate and other assets.
Stock Options
Posted by: Geraldson, November 16, 2017 04:46PM
A family member works for a large corporation who has granted him stock options in the company stock. I'm fairly well versed in income tax matters as a non-professional, but have never dealt with this. I'm curious as to the basics. If he exercises his \$40 option and the stock is now \$60, how is it taxed if he immediately sells the stock? And if he keeps the stock for over a year? I don't expect a full tutorial here, but some basics on how this works will get me pointed in the right direction. Thank you!

Re: Stock Options
Posted by: kaneohe, November 16, 2017 05:01PM
lots of info here:

[fairmark.com]

If they are non-qualified options, typically the bargain element (60 - 40 = 20/sh) is combined in the W2 w/ wages and withholding is done on that extra income. There may be a small component of ST gain/loss if the stock is immediately sold. If the stock is held > 1 yr, the bargain element is taxed the same way and the difference between the stock price and sale price is taxed as LTCG
(basis= 60)

Re: Stock Options
Posted by: Geraldson, November 17, 2017 12:20PM
Thank you Kenohe. So it appears that if, in my example above, the taxpayer exercises his option to buy a \$60 stock for \$40, that \$20 discount will be taxed at ordinary income rates if he immediately sells the stock. But if he holds it for a year, it's taxed at the capital gains rate. Right? And if he holds the stock, taxation of that initial discount can be deferred until he sells the stock, perhaps indefinitely? Is that correct?

Re: Stock Options
Posted by: kaneohe, November 17, 2017 01:59PM
No, that is not correct. Sorry for the confusion.

"bargain element (60 - 40 = 20/sh) is combined in the W2 w/ wages and withholding is done on that extra income. ......................... If the stock is held > 1 yr, the bargain element is taxed the same way and the difference between the stock price and sale price is taxed as LTCG (basis= 60)"

What I meant by the above is that if you sell immediately upon exercise, the bargain element is included in wages. If you hold it for > 1 yr, the bargain element is taxed the same way (as wages) and the bargain element as LTCG" The meaning would have been different if I had swapped two phrases in the last sentence.

)

Please note that, as noted previously, this discussion is for non-qualified stock options. If you have other types of options, answer could differ.

Re: Stock Options
Posted by: Geraldson, November 17, 2017 02:37PM
That was a good link. So please bear with me and let me restate how I think this works, for you to confirm or correct.

(Using the example in the link). My company grants me an option to buy 1000 share of stock at \$15. The stock is worth \$40 at the time I buy it. So there is \$25,000 of compensation income at the time I exercise the option and buy the stock. Right? Is that "compensation" income subject to FICA as well as ordinary income tax? So I have to come up with the \$15,000 to buy the stock and will owe tax in April of the following year on \$25,000 of compensation income beyond my normal compensation. What's not clear is how I can convert that \$25,000 into LTCG and/or defer the tax indefinitely. Can I do both (LTCG and defer tax on the \$25,000 bargain element) by holding the stock for more than a year?

Re: Stock Options
Posted by: kaneohe, November 17, 2017 03:24PM
I don't think so. The bargain element is taxed as wages when you exercise the option(not sure about FICA but I think that would be taken out since it's being taxed as wages) AFAIK the only part that you get LTCG for on is if you hold the stock > 1 yr and it appreciates above \$40 which is your basis.

Re: Stock Options
Posted by: Geraldson, November 17, 2017 03:50PM
So are you saying that, if you don't want to own the stock long term, there's no advantage to owing the stock for a year (other than the LTCG, if the stock rises beyond your basis)?

Re: Stock Options
Posted by: kaneohe, November 17, 2017 04:17PM
Basically you are buying the stock at near market value.
If you wouldn't buy it in the market then, there seems to be little advantage to holding it from the option
(you might save brokerage fees). In addition you have to come up w/ the cash to buy it.

Many folks exercise the cashless/same day sell option.
You put up no cash and basically get the difference between selling price and purchase price (bargain element) .

[fairmark.com]

Re: Stock Options
Posted by: Geraldson, November 17, 2017 06:08PM
Is there any way to convert the "bargain element" taxable portion to the long term capital gains rate?

And can someone clarify if the taxation on this "bargain element" is subject to FICA/payroll taxes?

Thank you for your patience here. I'm fairly "tax literate", but this is new turf for me.

Re: Stock Options
Posted by: Art, November 18, 2017 09:42PM
For Non Qualified Stock Options, the Bargain Element should always be included in W-2 Box 1 and 5 and 3 (depending on where you are with maxing out of Box 3 amounts).

W-2 box 12 V should show the bargain element amount already included as income.

If you do a same day exercise and sale, you have zero or slight ST capital loss. If you do receive a 1099B for the sale part of this transaction file a schedule D and its feeder form.

All of the NQSOs I have seen in the past 20 years or so have been same day exercise and sale.

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