ISO (Incentive stock option):
1. No income is recognized by employee when ISO is granted or exercised.
2. There is income tax when stock is sold. (Qualifying disposition is Long term Capital gain)
Example: In 20X1, Ross was granted an ISO by her employer as part of an executive compensation package. Ross exercised the ISO in 20X4 and sold the stock in 20X6 @ a gain. Ross was subject to regular tax for the year in which the => STOCK WAS SOLD.
Explanation:
The requirement is to determine when Ross was subject to “regular tax” with regard to stock that was acquired thru the exercise of an ISO.
There are no tax consequences when ISO is granted to an employee.
When the ISO is exercised, any excess of the stock's FMV over the option price is a tax preference item for purposes of the employee's AMT.
However, an employee is not subject to regular tax until the stock acquired thru exercise of the option is sold.
DISQUALIFYING DISPOSITION: Not meeting the holding-period requirement of two years from offering/grant and one year from purchase is called a “disqualifying disposition”
* The stock is sold within 2 years after the ISO is granted.
* The stock is sold within 1 year after the ISO is exercised.
Ordinary Income = Spread
Spread = (FMV @ exercise date – exercise paid)
NQSO (Non-Qualified Stock options)
1. No Income recognition upon GRANTED.
2. Income recognition upon EXERCISED ( treat it as an ordinary income)
3. When it is sold later, then its a CAPITAL GAIN or LOSS.
ESPP: (Employee Stock Purchase Plan)
1. Stock in an ESPP is usually purchased at a 15% discount from what it's selling for on the open market.
2. Your purchases are deducted from your paycheck.
3. When you sell the stock, you pay tax on the difference between what you paid for the stock and what you sell it for.
4. If you are selling at a profit, an amount up to your original discount is included in your W2 wages and taxes are withheld immediately.
There are 2 major types of ESPPs:
1. Qualified ESPPs => The purchase-price discount can be any amount up to 15%
2. Non-Qualified ESPP => The purchase-price discount can be any amount up to 18%
Let's say your company offers a 10% discount on the stock price on the first day of the offering period or the last day of the offering period, whichever is less:
Stock price on first day of offering period = $10
Stock price on last day of offering period (tax basis) = $12
Purchase price of the stock = $9
Stock price when you sell = $14
Although you fail to meet the two-year holding period requirement, you do hold for more than one year from the date of purchase and will recognize the following:
Ordinary income ($12 – $9) per share (aka) Spread = $3
Long-term capital gain ($14 – $12) per share = $2
When the market price on the purchase date (e.g., $10.00) is lower than the market price on the offering date (e.g., $12.00), you will, oddly enough, recognize less ordinary income in a disqualifying disposition (e.g., $10.00 purchase date market price – [$10.00 x 0.90 = $9.00] = $1.00 in ordinary income) than in a sale that meets the holding-period requirements discussed below (e.g., $12.00 grant date market price – [$12.00 x 0.90] = $10.80 => $1.20 is ordinary income)
When you sell the shares after “holding them for two years” from the start of the offering, you will recognize the following:
Ordinary income ($10 – $9) per share = $1
Long-term capital gain (Sales price $14 – (ordinary income $1 + purchase price $9) per share) = $4
Please correct me, if I am missing any key points.
.