Bear with my Internet- income tax noobishness, but this is my first time doing this.
Last summer, I exercised a bunch of non-qualified stock options that my company had granted to me. I sold it through a sameday cashless exercise
It looked like the brokerage took some of that profit away to withhold as income taxes. Great, I thought, it’ll be on my W-2 and I won’t owe any more taxes! All was well.
But as I start stuffing numbers into Turbotax, it seems as if I have an additional requirement to pay short-term capital gains tax on that profit. So I’m ending up paying both 28% income tax AND 28% short-term capital gains tax on the profits from that sale?
Is this how it’s supposed to be, or am I missing something?
In a case of exercising a nonqualified option with immediate cash out, only income taxes should apply. The situation only gets screwy if the option is exercised and then the stock is held. If the stock is held a person owes income tax on what they would have gotten on an immediate cash out, and they may qualify for capital gains or losses depending on where the stock goes from there.
As always, internet advice is just that. Seek qualified opinions before using internet advice to prepare taxes.
It’s like your normal paycheck, Roger. They withhold some taxes in advance at the behest of the IRS so that at the end of the year you’ve already paid in quite a bit of what you owe. That 28% (they may have withheld 28% exactly due to some kind of failure to certify your SSN… hey it happens) ought to be counted on your income taxes as money you’ve already paid in.
This doesn’t apply to you, Roger, since you’ve already cashed out, but new tax rules passed within the last year will sock you hard if your company issues stock options with an exercise price below the current market value of the shares on the option issuance date. You essentially get taxed on the difference between the exercise price and the market price of the underlying shares when the option is issued, whether you exercise (and you may not be able to exercise under the option plan) or not.
No, 28% is 28%, period. There’s no double tax thing going on. However, if your stock options were worth substantially more than your regular annual income, then you may have to deal with Alternative Minimum Tax, which is another small penalty designed to keep you from making too much money.
There are two taxable components to stock options:
The difference between the exercise price of your options, and the price of the underlying stock, at the time the option is issued, is an employee benefit taxed as normal income. In other words, if you are given the option to acquire 100 shares for $0.20/share, but the share price at the time of the issuance is $2.00, you’d have to pay $1.80 per option as an employee benefit – this almost NEVER happens, however, as companies issue options at fair market value. Public companies also have restrictions on the price discounts they can issue options at.
the difference between the exercise price and the price you sell them for is a capital gain (or treated as equivalent to capital gain) when you exercise. Since you did a cashless exercise, this is the only tax you’ll have to pay.
This doesn’t seem logical. If you exercise a stock option and say get 100 shares of OCP for $100 each, when the market price is $200, then that seems like $10,000 regular ‘employee benefit’ income type 1 above. If you then immediately sell it (with no fee I guess), that’s $0 in capital gains.
Well, I am not a tax lawyer, of course. Maybe it’s one of those ‘glass is half full’ things.
No, the “employee benefit” type income only happens at the time you’re ISSUED THE OPTION – at that point, if the option exercise price is less than the fair market value of the shares at the time, you have a taxable benefit. That really sucks, too, because you may never actually exercise your option to acquire shares, or the share price may go down to the point where your option is valueless (the shares are worth less than the exercise price), but you don’t get to claim that “loss” as a deduction from your income – so you might pay tax on something that you actually never receive. For that reason, among others, options are essentially never issued at an exercise price below their fair market value (there are some minor exceptions, but that’ll just get more confusing).
The difference between the exercise price at the time you EXERCISE THE OPTION and the fair market value is the normal, capital gains (equivalent) tax.
Yeah, and now that companies have to expense options at the time of issue, a lot of companies are having to cut way back on how many options they give out. There’s a model used to value the options at issue (Desslock, help me out, I can’t remember the name of the model) but nobody believes it is accurate - it just generates a dollar figure that the company has to account for under S-O. I dunno, I’m not an accountant, but it seems crazy to force companies to treat something as a value that may never get exercised or exercised at a significantly lower value, x years down the road.
It’s accurate to the extent that it can be given that there is a built in, “We don’t know what the fuck random variable should go in here, so let’s guess,” factor to the formula.
If you think about it, an option’s value depends on the likelihood of the stock price increasing (including a volatility component) and the term of the option (given a greater period of time, the option is more likely to come into the money at some point), along with a baseline (i.e. risk free interest rate) component. At least one of those things can not be determined with accuracy, otherwise we could all make a shitload of easy money on the stock market. Therefore, the formula can not by definition be accurate.
Black-Scholes. There are multiple ways of calculating the expense, however, and no mandatory method – the process is pretty artificial, since they are not really “expenses”, especially since any dilution is contingent and quite possibly utterly irrelevant.
Expensing options deliberately distorts reality on the grounds that doing so provides a better guestimate of what the future may be than you’d get without performing that artificial projection. It’s a bit goofy, really, and somewhat of a recipe for disaster if comparable companies don’t use the same methods.