Incentive Stock Options (ISO)

If you sell stock by exercising incentive stock options (ISOs), the type of tax you’ll pay depends on your holding period.

The holding period is:

• How long you held the stock after you exercised the option
• How long after the option was granted that you sold the stock

Part of the stock sale’s profit will be reported as ordinary income if either of these is true:

• You held the stock you bought for one year or less after you exercised the option.
• You held the stock for less than two years after the option was granted to you.

Your employer should include the amount reported as ordinary income in your total earnings on your W-2. Any remaining gain is reported as a capital gain. If you sold the stock for a loss, report the entire loss as a capital loss.

Report stock sale profits as a capital gain or report losses as a capital loss if both of these apply:

• You held the stock you bought for more than one year when you exercised the option.
• You held the stock for two or more years after the option was granted to you.

Reporting the sale

If you follow IRS rules when you report the sale of stock bought through an ISO, you’ll avoid being taxed twice on the same income.

The broker your employer uses to handle the stocks will send you a Form 1099-B. The form will include:

• Name of the stock
• Number of shares sold
• Price you sold the stock for
• Your net proceeds (in most cases)

Read the 1099-B to see if the expenses related to the sale were excluded from the reported proceeds. If expenses weren’t included, add them in to the cost (or basis) of the stock you sold.

To learn more, see the Sale Expenses tax tip.

You might receive a statement from your employer showing the amount included in your W-2 income (if any). If you’re not sure if any of your gain was in your W-2 income, check with your employer.

To learn more, see Publication 525: Taxable and Nontaxable Income at www.irs.gov.

ISOs and the Alternative Minimum Tax (AMT)

ISOs can affect your AMT. You might exercise the option and not sell the stock in the same year you exercised it. If so, you’ll need to add the difference between these two to your AMT income:

• Amount you paid for the stock
• Stock’s fair market value (FMV) on the day you exercised your option

The FMV on the day you exercised the option is your AMT basis. When you sell your stock, use the AMT basis for figuring the AMT gain or loss. For AMT purposes, your gain will be lower — or your loss will be greater — than for regular income tax purposes. Report the difference as an AMT gain / loss adjustment on Form 6251: Alternative Minimum Tax, Part II.

Keep a record of the AMT basis in your files so that you can correctly figure the AMT gain or loss when you sell the stock. The capital loss deduction for net AMT losses is limited to $3,000.

To learn more, see Form 6251 instructions at www.irs.gov.

To help figure any AMT on the exercise of your ISO, see your Form 3921. Your employer must give you Form 3921 by Jan. 31 the year after you exercise your stock options.