Tax Planning for Stock Options

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If you or your spouse have non-qualified stock options that you execute, you may incur a tax liability. The tax liability occurs on the difference between the stock’s market value and the exercise price (your right to buy the stock at a lower price). You’re taxed on the difference at your regular tax rate, but it’s important to know that you’ll incur this tax liability.

How long you hold the stock and the price you sell it at will determine if you have a capital gain or loss. If you have a capital gain, you’ll pay appropriate taxes at the time you sell the stock, but if you have a loss, you can write off the loss and reduce your tax liabilities.

In other words, if your exercise price is higher than the market price when you sell the shares, you’ll have a loss, but if it’s lower than when you sell the stocks, you’ll have a gain. How long you hold onto the stocks determines if you pay short-term capital gains taxes (higher) or long-term capital gains taxes (lower).

Here’s an example of how it works.

On January 1, 2017, your employer granted you a non-qualified stock option for 1,000 shares at $30 a share. The company’s stock price rose to $40 per share, so you exercised your stock option, buying them at $30 a share on January 1, 2019.

On January 1, 2021, the company’s stock rose to $55 per share and you sold your stocks. In 2017, you paid taxes on the $10,000 bargain element (the difference between your exercise right and the market price). This was taxed at your regular tax rate. Let’s say you were in the 24% tax bracket, you’d pay $2,400.

Your holding period began January 2, 2019, and your basis is $40 per share. When you sold the shares, you had a capital gain of $15,000 (1,000 shares x $15 per share). You’d pay long-term capital gains taxes on the earnings, which for example’s sake we’ll say is 15% or $2,250.

This means you’d walk away with a profit of $20,350 after taxes.

Non-qualified stock options can be a valuable employee benefit if you understand how the taxation works and how to manage it to keep your tax liability low. If you’d like to learn more about how this works, contact us today.