Sale of Mature ISO Stock

You may have to report compensation income if you sell stock you acquired by exercising an ISO before you meet the special holding period requirement for incentive stock options. For an explanation of the special holding period, and the results of a disqualifying disposition, see Early Disposition of ISO Stock.

Once you satisfy the special holding period, you have mature ISO stock. A sale or other disposition of this stock isn’t a disqualifying disposition. Any profit you have from a sale will be capital gain, not compensation.

Some people receive an added benefit when they sell ISO stock. Selling this stock may help you claim an AMT credit that will reduce or eliminate the tax you pay on sale of the stock.

Reporting sales of stock

For some people, a sale of stock from an incentive stock option is the first experience in selling stock. If you aren’t familiar with the rules it may appear that you’re being taxed on too much income.

When you sell stock through a broker you’ll receive a form reporting the results of that sale: Form 1099-B. This form does not tell how much gain or loss to report. It merely tells how much you received from the sale. It’s up to you to figure how much gain or loss you report from the sale.

To do this you need to know your basis for the stock. Normally your basis for stock is simply your cost for the stock (including brokerage commission, if any). When you sell mature ISO stock you don’t report any compensation income, so the general rule applies: your basis is equal to your cost for the stock.

Gain or loss

Subtract your basis from the amount you received in the sale of your shares to determine your gain or loss. You have a capital loss if the result is a negative number; otherwise you have a capital gain. Your gain or loss will be long-term because your stock isn’t mature ISO stock until a year after you exercise the option.

AMT consequences

It’s extremely important to understand, and properly report, the alternative minimum tax consequences of selling mature ISO stock.

When you exercised your ISO you had to report an AMT adjustment that may have required you to pay alternative minimum tax. Regardless of whether the adjustment resulted in a need to pay AMT, the adjustment caused you to have a dual basis in your ISO stock. For purposes of the regular income tax your basis is simply the amount you paid to buy the stock. But when it comes to the AMT you increase your basis by the amount of the AMT adjustment.

The upshot is that you’ll normally report a negative AMT adjustment — an adjustment in your favor — when you sell your ISO stock. On Form 6251, the form used to report your AMT calculation, the adjustment should be entered as a negative number. This adjustment can reduce your taxes:

• If you’re otherwise subject to AMT liability in the year you sold the ISO stock (perhaps because you exercised a new ISO), the negative adjustment will reduce or eliminate the amount of AMT you pay in the current year.
• If you aren’t subject to AMT liability in the year you sold the ISO stock, the negative adjustment increases the gap between your regular tax and the tax that’s calculated under the AMT rules. The result may be a larger AMT credit in the year you sell the ISO stock.