What you need to know about your ISOs when you receive them.
Table of Contents
Generally you have nothing to report in connection with an incentive stock option prior to exercise. There are a few points you should be aware of nonetheless.
Receiving an ISO
There’s no tax to pay, and nothing to report, at the time you receive an incentive stock option. You should, however, take care to do the following:
- Read the option agreement carefully, making certain you understand your rights — and any circumstances in which you could lose those rights.
- Obtain copies of any other relevant documents, such as the stock option plan under which the option was issued and any summary of the plan or agreement. Review these items, then file them with the option agreement in a safe place.
- Start planning now for the eventual exercise of your option. When do you expect to exercise? Will you need to come up with a large sum of cash? If so, how will you do so? What tax considerations will apply?
No tax when option vests
You may receive an option that isn’t immediately exercisable. You’re permitted to exercise the option only if you continue to work for the same company for a stated period.
Example: You receive an option to buy 300 shares of your employer’s stock, but you’re not permitted to exercise the option immediately. If you’re still employed with that company a year later you become eligible to exercise half of this option. After another year of employment the option is fully exercisable.
The dates on which the option becomes exercisable are called the vesting dates. These dates are obviously significant, but you don’t report income on these dates.
Note: The rule is different when you receive grants of stock from your employer. As a general rule, you do report income when a stock grant vests. But there’s nothing to report on your income tax return when an option grant vests.
Beware of changes
For one reason or another your employer may consider changing the terms of an incentive stock option you hold. Some types of changes are OK, but others can turn your ISO into a nonqualified option. Be sure that a qualified tax expert has reviewed this question before accepting any changes in your ISOs.