Employee stock options NQSO or ISO after splits

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  • #36808
    miamicuse
    Participant

    I have some questions regarding employee stock options for NQSO and ISO.

    I worked for a private company who granted some stock NQSO options to me in 2001 and some ISO options in 2005. I exercised the options in 2008.

    At the time of the exercise, I paid income tax for the difference between FMV and option price for the NQSO but no taxes for the ISO.

    Over time the stock split three times. Each time I received additional paper certificates for additional shares equal to what I had at the time.

    SO let’s say my original grant of 1000 NQSO shares after exercised was certificate A1, and the original grant of 3000 ISO shares after exercise was certificate B1.

    A1 NQSO 1,000
    B1 ISO 3,000

    In 2009 I received a new stock certificate C1 of 4000 shares.

    In 2011 I received another stock certificate D1 of 8000 shares.

    In 2015 I received another certificate E1 of 16000 shares.

    The company has a buy back program and I sold 4000 shares back to them at a substantial profit. I surrendered the original certificates A1 and B1.

    Since I surrendered my original certificates, I assume I should pay tax for original costs. Which was the difference between sale price and FMV for the NQSO shares of 3000 and the difference between sale price and option price for the ISO shares of 1000. Correct?

    Or should I split adjust all the 32000 shares and assign to each of them the same split adjusted cost?

    Which method is correct?

    If the first method is the correct approach, then the stock certificates that comes later C1, D1, E1 would all have a cost basis of zero, right?

    If the cost basis is zero, do I still need to keep track of how many shares in C1, D1, E1 are NQSO and how many ISO? Or does it not matter anymore if they are both cost at 0.0?

    #37092
    Kaye Thomas
    Moderator

    First be sure you have the correct initial basis for the stock acquired using NQSO. This is the amount paid to exercise the option, increased by the amount of income you reported from exercise of the option. For example, if you paid $5,000 to exercise the option when the shares were worth $65,000, you would have reported $60,000 as additional income from exercise of the option. Your basis for the shares would be $65,000, exactly the same as if you received a cash bonus of $60,000 and used that money, together with $5,000 from savings, to buy $65,000 worth of stock.

    Second, most people pay alternative minimum tax (AMT) when they exercise an ISO. Afterwards, they’re usually able to recover some or all of this tax in the form of a credit. In some cases, the trigger for recovering credit is sale of the ISO shares. You say you paid no tax when exercising the ISO, and if that’s the case, you won’t claim any AMT credit. You may want to double check, though.

    Now to your question. Stock splits cause whatever basis you have in your shares to be split among all resulting shares. If your stock had basis of $20 per share before a 2-for-1 split, you end up holding twice as many shares with a basis of $10 per share. Also, the number of shares in each category doubled. In your example, certificate C1 includes 1,000 shares that would be treated as coming from exercise of NQSO and 3,000 shares from ISO . . . and so on for the other splits.

    #53416
    miamicuse
    Participant

    Thank you for the reply and explanations.

    (1) Yes, the NQSO options I paid tax on the bargain element between the exercise price and the FMV at the time of the exercise. It was taxed as additional income which at the time threw me off totally because it kicked my income bracket to another level so I was taxed even higher. So now I have to pay capital gains taxes on the difference between the FMV at the time and the buy back price.

    (2) I have to look further into whether I paid AMT when I exercised the ISO. I was incorrect in stating I didn’t pay taxes, I did, but not for exercising the option, but because at the time I exercised it cashlessly. So I gave up some shares to pay for it. Again because I did not do my homework correctly, at the time I was thinking I am exercising stock options I held for a long time, if there would be any taxes it would be long term gains. Oh boy was I wrong, the cashless exercise was equivalent to an instant short term capital gains, I exercised and sold shares the same day and used the cash to pay for the rest of the shares. Taxed as short term gains. Did I pay any AMT? I don’t think but I will double check.

    (3) So I need to split the shares evenly. I was hoping to avoid that by calculating the basis on the initial lot of the shares and consider the split shares a basis of zero so that I can avoid having to keep track of how many shares of NQSO and ISO in each lot for the future. Looks like I can’t do that any more. Oh well.

    Another question I have is, because it’s been a long time with these stock options, and my original company has been merged with another, then they too were acquired by another company…and then instead of paper certificates, they company hired COMPUTERSHARE and we sent in our paper certificates so they can manage them electronically and do the private market buy backs. They no longer have the cost basis information and didn’t include that with the 1099. They put 0 as the cost basis. This means I have to adjust the cost basis to reflect the actual numbers. Is that typical? Does that trigger an audit from the IRS?

    #53424
    Kaye Thomas
    Moderator

    I don’t know if this is typical, but it’s not surprising. They should have checked box 5 on your Form 1099-B, or otherwise indicated this is a “noncovered security.” This would tell the IRS that the company isn’t reporting the basis information for the shares, and the IRS will expect you to come up with your own figure for basis. If their form shows zero basis without indicating the shares are “noncovered,” you can request a corrected Form 1099-B from the company. You wouldn’t be asking for a form showing the correct basis, but just for the “noncovered” indication.

    However, even if you can’t get this, you can put your correct basis on the form with a proper code indicating it’s different from the one on Form 1099-B, and attach an explanation. IRS expects to see this happen on many returns, so it is unlikely to trigger an audit.

    #56281
    miamicuse
    Participant

    Thank you, I will request a new 1099 and see if they can do it correctly this time.

    One other question, if my original shares were exercised in say 2008, then the stock split in 2011 and 2015. Does it mean I have three lots of this stock each having different “purchase/open” dates or is the open date for everything the original exercise date? I understand the date doesn’t matter in this case due to the length of time they are all long term gains, but it would be nice to know which date to use for the splitted shares.

    #56282
    Kaye Thomas
    Moderator

    Shares received in a split take the holding period of the original shares.

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