What They Are
An incentive stock option (“ISO”) is the right to purchase employer stock for a stated price for a specified period of time. ISOs are only granted by employers to employees and constitute actual ownership of shares. The date an employee is given the purchase right is the “grant” date and the date the employee purchases stock pursuant to the right is the “exercise” date.
What to Know
Neither the grant nor exercise of an ISO require an employee to include amounts in gross income for that tax year. However, the employee may be subject to alternative minimum tax (“AMT”) in the year of exercise. The employee must report taxable income or deductible loss when the stock purchased through exercise of an ISO is sold. If the stock is sold at least 2 years from date of grant and 1 year from date of exercise, the sale or disposition is treated as a “qualifying” disposition and the “spread” or difference between exercise price and sale price is taxed at capital gains rates. Where these holding requirements are not met the sale is treated as a “disqualifying” disposition and the spread between the fair market value (“FMV”) at exercise and FMV at sale is taxed as ordinary income. Following exercise, the employer should issue Form 3921 to the employee, and following the first sale or transfer of stock acquired through exercise of an ISO the employer should issue Form 3922. These forms report the dates and values necessary to determine the correct amount of capital and ordinary income to report on the employee’s return.
Note: The AMT adjustment in the year of exercise can result in substantial income tax liability. We highly recommend consulting with a competent tax advisor prior to exercise.
Contact Hone Maxwell LLP today with questions about ISOs and for related tax planning.