Helpful Tips
If you have Incentive Stock Options (ISOs), what are their tax implications? It can be very, very complicated. For instance, I had an interesting discussion with a friend last week.
Rob works for a tech company and he exercised his ISOs in January 2022 at $150 per share, when the share price was at $160. He intended to use a qualified disposition – own the shares until at least January 2023 – for favorable tax treatment.
However, the share price has languished to $90 and he owns underwater ISOs. He is confused about what to do. Remember, if he holds his exercised shares at least two years after the grant date and one year after he exercised them (January 2022), the sale is qualified, and taxed at more favorable long-term capital gain rates. He has met the requirements for a qualified disposition, but the share price hasn’t cooperated with him.
Create “Options” For Your ISOs
So what can he do?
First, look on the bright side of life!
Second, he can sell the shares and employ several tax planning strategies.
If he sells the shares of the underwater ISOs, the losses can be used to offset capital gains. For example, Rob exercised ISOs and now owns 200 shares, and his loss stands at $12,000 (($150 – $90) x 200 = 12,000)). He can sell another investment for a gain of $12,000 and create a tax-free transaction.
Alternatively, he can use the losses to offset ordinary income ($3,000 annual limit), and carry the losses forward to be used in future tax years. He can use $3,000 each year over the next 4 years to offset his ordinary income ($12,000 total).
Third, he can hold onto the shares. Hopefully they increase in value well over the $150 exercise price. He also has to be mindful of the amount of employer share ownership in his portfolio.
How to Report Taxes for ISOs
Here’s how Rob will report his transactions to the IRS. You can follow his lead for your ISOs.
First, the ISO exercise at $150 per share is qualified and his custodian will send him a Form 1099-B. He will also use the “Supplemental Tax Information” from the custodian’s website and work with his accountant to calculate the appropriate gains/losses and any AMT credit. The tax reporting depends on what he does with the ISO shares after exercise.
If he decides to hold onto the shares and not sell them – a qualified sale – his company will send him a Form 3921 reporting the share exercise in the calendar year it occurred. Rob will use this information on the Form 6251 to calculate any AMT due.
Rob did not go down the path of a disqualified sale. But if he were to do so, here are some tips. Depending on the sale price, Rob’s employer would report all or some of the profit as ordinary income on his W-2 in the year of the sale. His custodian will send him a Form 1099-B, and he should also use the “Supplemental Tax Information” for accurate reporting.
What Else to Think About
With ISOs, you have concentration risk in your employer stock. This can be more important than the tax implication for qualified or disqualified ISO exercises, not to mention underwater ISOs. Don’t let the tax tail wag the dog of employer stock! Taxes are just one component of your finances.
There’s a lot to digest with ISOs. Instead of trying to figure it out on your own, I suggest sharing the option details with someone who specializes in equity compensation planning. We can speak about your ISOs during a free consultation.