Stock Option Taxation
By Bruce Delbecq
Community Bank Advisor, 2007 Winter 

Now that 2007 is upon us, the checklist below of stock option taxation, withholding, and IRS reporting requirements, should be helpful for both incentive stock options (ISO) and nonqualified (NQ) options.

Grant

ISO and NQ: No tax, withholding, or IRS reporting.

Note: The requirements under IRC §409A require non-qualified options to also be granted at no less than fair market value (FMV).

Exercise

ISO: No tax, withholding, or IRS reporting.

Note: The employer must provide to the employee a statement with the FMV of the stock at exercise and the amount of gain since the spread is an “item of preference” for alternate minimum tax (AMT) purposes. Advance planning with your tax professional is advised.

NQ: The difference between FMV at exercise and amount paid at exercise is Form W-2 compensation income, subject to both income tax and FICA withholding, and reporting in box 12 of Form W-2. Income tax withholding is generally at the 25 percent special payment rate. (Directors receive a Form 1099 without withholding.)

ISO Disqualifying Disposition

If the exercised shares are transferred before the expiration of the required holding period — the latter of (1) two years from the date of grant, or (2) one year from date the stock was transferred upon exercise — a disqualifying disposition will occur. The difference between the FMV at exercise and amount paid at exercise is Form W-2 compensation income to the employee and reported in box 12 of Form W-2 for the year in which the disqualifying disposition occurs. No income tax withholding is required, and no FICA is payable.

Note: The employer must track ISO holding periods to fulfill its reporting responsibilities (and claim a compensation income tax deduction) in the case of a disqualifying disposition.

Sale of Stock