FAQS
What are the U.S. federal tax effects of incentive stock options?
- Operations
- Tax
There are no taxes due when an incentive stock option (ISO) is granted or exercised. If the stock is held for more than one year after the date of exercise of the ISO and more than two years after the date of grant of the ISO, any gain or loss upon the sale or transfer of the stock will be a long-term capital gain or loss.
An earlier sale or transfer generally will be a disqualifying disposition that results in ordinary income tax on the lesser of:
- the excess, if any, of the fair market value of the shares over the exercise price paid for the shares (the spread) at exercise; or
- the excess of the proceeds from the sale or transfer over the exercise price.
To the extent an optionee realizes ordinary income in connection with a disqualifying disposition, the company generally may take a corresponding deduction.
Please be aware that the exercise of ISOs may affect the determination of an optionee’s alternative minimum tax (AMT). When an optionee exercises an ISO, he or she will be required to include the amount equal to the spread at exercise as an adjustment item in the determination of his or her AMT. However, if the optionee sells or transfers the shares in the same calendar year as the date of exercise of the ISO, then no adjustment with respect to those shares is included in the determination of the optionee’s AMT.
Determination of the AMT is complex and highly dependent on the optionee’s individual situation. As a result, optionees should consult with their tax advisers before exercising any ISOs to understand the tax consequences of exercising ISOs and the sale or transfer of shares.
Please note that the U.S. federal tax consequences of a disqualifying disposition of shares acquired through the early exercise an ISO will be different from those described above.
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