Employee Stock Options: Tax Treatment and Tax Issues

The vesting schedule is followed by an expiration date. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation. Although both options allow employees to purchase a set amount of shares of company stock at a fixed price for a limited period of time, they are treated differently for tax purposes. For more information on employee stock options and how different choices affect your taxes, please contact Norman LeBlanc, CPA or any member of our Tax Services Group at In view of this, the OECD's Committee on Fiscal Affairs is undertaking work on the treatment of stock-options under tax treaties, the domestic treatment of stock-option schemes and the transfer pricing implications of stock-option schemes. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates. Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.

Employee Stock Options: Tax Treatment and Tax Issues Congressional Research Service 2 Suppose that Ceecorp’s stock had risen to $30 a share on January 1, , when the CFO became vested with the right to buy shares, with no further restrictions on her ownership of the stock.

What's an Employee Stock Option?

Tax Treaties A number of tax treaty issues arise in considering employee stock-options: Timing mismatches for employment benefits. Determining to which service an option relates. Distinguishing employment income from capital income. Differences in valuation between markets. Domestic Tax Treatment Work in this area is intended to provide information and analysis to assist countries in reaching their own policy decisions.

The analysis focuses on three areas: Description of current tax treatment of employee stock-option schemes in OECD countries.

Analysis of what form of tax treatment would provide neutrality in comparison to wages. Identification and discussion of arguments that are advanced in favour of and against taxing employee stock-options differently from wages. Transfer Pricing Issues This area of work analyses the implications of employee stock-options for inter-company transactions and the arm's lenght principle.

Should the issuing company charge the employer if different for the stock-options? The vesting schedule is followed by an expiration date. On this date, the employer no longer reserves the right for its employee to purchase company stock under the terms of the agreement. An employee stock option is granted at a specific price, known as the exercise price. It is the price per share that an employee must pay to exercise his or her options.

The exercise price is important because it is used to determine the gain, also called the bargain element, and the tax payable on the contract. The bargain element is calculated by subtracting the exercise price from the market price of the company stock on the date the option is exercised.

The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts. The taxation of stock option contracts depends on the type of option owned. Although the timing of a stock option strategy is important, there are other considerations to be made. Another key aspect of stock option planning is the effect that these instruments will have on overall asset allocation.

For any investment plan to be successful, the assets have to be properly diversified. An employee should be wary of concentrated positions on any company's stock. While you may feel comfortable investing a larger percentage of your portfolio in your own company, it's simply safer to diversify.

Conceptually, options are an attractive payment method. In practice, however, redemption and taxation of these instruments can be quite complicated. Most employees do not understand the tax effects of owning and exercising their options. As a result, they can be heavily penalized by Uncle Sam and often miss out on some of the money generated by these contracts. Remember that selling your employee stock immediately after exercise will induce the higher short-term capital gains tax.

Waiting until the sale qualifies for the lesser long-term capital gains tax can save you hundreds, or even thousands. What's an Employee Stock Option? Grant Date, Expiration, Vesting and Exercise To begin, employees are typically not granted full ownership of the options on the initiation date of the contract, also know as the grant date. Taxing Employee Stock Options The Internal Revenue Code also has a set of rules that an owner must obey to avoid paying hefty taxes on his or her contracts.

For non-qualified stock options NSO: The grant is not a taxable event. Taxation begins at the time of exercise. The bargain element of a non-qualified stock option is considered "compensation" and is taxed at ordinary income tax rates.

The sale of the security triggers another taxable event. If the employee decides to sell the shares immediately or less than a year from exercise , the transaction will be reported as a short-term capital gain or loss and will be subject to tax at ordinary income tax rates.

Grant Date, Expiration, Vesting and Exercise

This report explains the tax treatment of various types of employee stock options recognized by the Internal Revenue Code, examines some of the issues that have arisen because of the real and perceived tax benefits accorded employee stock options, discusses the Financial Accounting Standards Board’s (FASB) rule for expensing . Incentive stock options (ISO) receive special tax treatment: The grant is not a taxable transaction. No taxable events are reported at exercise. However, the bargain element of an incentive stock option may trigger alternative minimum tax (AMT). The first taxable event occurs at the sale. What’s News in Tax Analysis That Matters from Washington National Tax Stock Option Compensation—Warnings for the Unwary. Stock options are a popular form of compensation provided to employees of corporations. Although commonly used, compensatory stock options involve a number of tax issues that are frequently .