Tax Issues for
Employee Stock Options
Tax Treatment
Varies Depending on the Type of Stock Option
A common method of compensating employees is to grant them
an option to purchase stock in the company at a price lower than fair
market value. While this seems like a great bargain, it may bring
unexpected tax consequences.
Generally, no income results upon grant or exercise of an incentive stock
option (ISO) or an option granted under an employee stock purchase plan (ESPP).
However, once the stock is purchased under an ISO, the taxpayer may be
subject to alternative minimum tax (AMT). This is because the IRS requires
taxpayers to include the difference between the exercise price and the
fair market value of the stock in the computation of AMT. This is what
often produces unexpected results.
If the stock is purchased through
the exercise and sold in the same tax year, AMT is not an issue; however,
the fair market value of the stock, less the option price, is included in
the employee’s W-2.
Likewise, if an
employee exercises a non-qualified stock option, the difference between
the exercise price the employee paid and the fair market value on the date
of exercise is taxable compensation to the employee and reported on the
employee's W-2.
