Contributed by KeriC, FreeTaxUSA Agent, Tax Pro
Income from the exercise of non-statutory stock option
If your employer grants you a non-statutory stock option (NSO), the amount of income to include, and the time to include it, depends on whether the fair market value of the option can be readily determined.
Readily determined fair market value - If an option is actively traded on an established market, you can readily determine the fair market value of the option. Refer to Publication 525 for other circumstances under which you can readily determine the fair market value of an option and the rules to determine when you should report income for an option with a readily determinable fair market value.
Not readily determined fair market value - Most non-statutory options don't have a readily determinable fair market value. This means there's no taxable event when the option is granted, but you must include the fair market value of the stock in your income, less the amount paid, when you exercise the option. You’ll have either taxable income or a deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss.
Ordinary income
When you exercise your options, you must recognize ordinary wage income on the discount you received for the stock. The wage income is equal to the difference between the discounted exercise price you paid for the stock and the price that everyone else must pay (fair market value). The income from the discount is reported on your W-2, Box 1.
Capital gain income
When you sell stock purchased with a nonqualified stock option, you'll need to report capital gain income. The stock sale will be reported on Form 1099-B. If you sell the stock immediately after exercising your option, all the income from the NSO is taxed as ordinary income tax rates. If the newly acquired stock is held for at least a year, the sale of the NSO stock will be taxed at lower, long-term capital gains rates. If you immediately sell the stock after you exercise the options, then the date sold and date acquired will be the same date and you'll have very little gain or loss from the sale of the stock.
Note: You'll need to make sure your employer has included the correct amount of income on your W-2. This should be reported in W-2, Box 12, Code V. If this is not there, ask your employer for a corrected W-2.
Example:
You exercise nonqualified stock options and receive 100 shares of stock at a grant price of $10 per share, but the actual value of the stock on the day you exercised the options is $50 per share. The discount you received when exercising the options is $40 per share or $4,000 for the 100 shares of stock. The $4,000 difference is included as wages on your W-2 along with any other wages for the year. Your cost basis for the 100 shares of stock is $5,000, which is made up of the $1,000 you paid out of pocket to exercise the options and the $4,000 included as wages on your W-2.
Below are what the W-2 and 1099-B would reflect using the figures from the example above.
Follow this menu path to enter a W-2: Income > Wages (W-2).
For this example, let’s see what a 1099-B for NSO options held more than one year may look like.
If the NSO was sold upon exercise, the 1099-B may look something like this:
No matter how long the NSO was held after being exercised, an adjustment would be entered on the tax return to account for the $4,000 taxed as wages on the W-2. When an adjustment is entered, the income won’t be double taxed (once as wages and once as a capital gain).
Follow this menu path to enter Form 1099-B: Income > Investments and Savings > Add an Investment > Stock Sales (1099-B). Proceed to the Tell us about your stock sale screen. Enter the information contained on the 1099-B. Continue to the Tell us more about your stock sale screen.
Below are screenshots of how you enter the information and add the adjustment for the above example:
