Nonstatutory Stock Options

[leerobea]

My understanding is that the taxable amount included in the W-2 is the FMV of the stock on exercise date less the the exercise price (amount paid). This amount is reported in box 1 of the W-2 and in box 12 with a code"V."
Further, the the code "V" amount is added to the employee's basis on schedule D to determine gain or loss.
I have a letter from the IRS which states: "The code "V" amount cannot be allowed as a deduction on Schedule D.
CAN SOMEBODY PLEASE TELL ME WHAT I AM MISSING???

Thanks.
Lee Robinson

[solomon]

Assuming the exercise and sale occur in the same year, I don't think you are missing anything.

Why did you receive such a letter from the IRS?

Now and then a client exercises a NSO but does not sell it in the same year. An inexperienced tax preparer might put the amount in Box 12 of the W-2 on Sch D as cost with no sales amount thus showing a loss (or "deduction"). That is not permissible.

[Kram BergGold]

Clarification

It says you can't dedcut it on Schedule D. This does not mean it can't be a part of basis to figure loss or additional gain. It just means you can't claim the entire amount as a loss.

[joanmcq]

Assuming the exercise and sale occur in the same year, I don't think you are missing anything.

Why did you receive such a letter from the IRS?

Now and then a client exercises a NSO but does not sell it in the same year. An inexperienced tax preparer might put the amount in Box 12 of the W-2 on Sch D as cost with no sales amount thus showing a loss (or "deduction"). That is not permissible.

And furthermore, how would they know it was part of the basis? Its not like you do a separate calculation (although one popular software program has been showing it as a subtraction on the next line with the notation "less gain reported on W-2" rather than added to the basis. A really stupid presentation that just eats up space, IMHO) If the stock was exercised, but not sold, the compensation portion would still be on the W-2, but there would be nothing on the D until sold.

[solomon]

If the stock was exercised, but not sold, the compensation portion would still be on the W-2, but there would be nothing on the D until sold.

I thought that is what I said.

[JohnH]

This looked like a good place to post another question about Non-Qualified Stock Options (or Non-Statutory Stock Options), Incentive Stock Options, and AMT.

Client is subject to AMT.
W-2 form shows Code V with $12,000.
Broker statement lists the Gross Proceeds and all details of the transaction, so client has a net loss on Schedule D of about $40 (two transactions).

So as I understand it, we now have to add the $12,000 back on Line 14 of the Form 6251. Doesn't really matter whether it's an NSO or an ISO when it comes to entering the info on the 6251 - all that matters is when it's exercised.

Somebody tell me I'm wrong...

[solomon]

Doesn't really matter whether it's an NSO or an ISO when it comes to entering the info on the 6251 - all that matters is when it's exercised.

Somebody tell me I'm wrong...

Then why would Line 14 request an ISO only?

[JohnH]

Looks like I am wrong, and glad to be in this case.
Rather than delete the previous post, I'll defer to Solomon's & Don's & Lion's wisdom. (Plus learn to read like Solomon & Don & Lion)

Thanks to each of you for getting my mind right.

[DonPriebe]

OK - you're wrong.

... So as I understand it, we now have to add the $12,000 back on Line 14 of the Form 6251. Doesn't really matter whether it's an NSO or an ISO when it comes to entering the info on the 6251 - all that matters is when it's exercised.

Somebody tell me I'm wrong...

Straight from the instructions for line 14 of the 6251

If you acquired stock by exercising an ISO and you disposed of that stock in the same year, the tax treatment under the regular tax and the AMT is the same, and no adjustment is required.

[Lion]

ISOs & AMT

Don't think AMT comes into play with NSOs.

For ISOs, the exercise results in an AMT adjustment, a deferral item. However, if ISOs are exercised and the stock is sold in the same year, then no deferral of income and, therefore, no AMT adjustment. (This came out of my old HRB text Employee Stock Options.)

[Burke]

This looks like a good place to jump in with something I have been thinking about for a while. Just exactly what makes an stock option an ISO versus a NQSO? Or vice versa. I have seen paperwork which show both for a client.

[Gene V]

This looks like a good place to jump in with something I have been thinking about for a while. Just exactly what makes an stock option an ISO versus a NQSO? Or vice versa. I have seen paperwork which show both for a client.

Taxation of Employee Stock Options

There are two types of stock options – Incentive Stock Options (ISO’s) and Non Qualified Stock Options (NQSO’s). ISO’s have more favorable tax opportunities than NQSO’s. If you are holding both ISO’s and NQSO’s and are contemplated a same day sale of a portion of your shares, you should sell your NQSO’s first to maximize the capital gain treatment in the future.

Taxation of NQSO’s - When you exercise an NQSO, you are taxed on the spread between the option price and the market value of your shares at the date of exercise. You pay income tax at ordinary rates on this spread whether you sell your shares or hold them. This is considered compensation and is also subject to payroll taxes (eg FICA and Medicare). Future appreciation is taxed at capital gain rates (generally 15% Federal rate) if you hold the shares for more than one year from date of exercise.

Taxation of ISO’s - ISO’s are not subject to regular income tax at the time of exercise. You will be able to receive long term capital gain rates on your entire gain if you sell your shares at least one year after they are exercised and two years after grant date. However, you may incur Alternative Minimum Tax (AMT) if ISO’s are exercised and not sold in the same tax year.

Pub. 525--page 11 and 12 has information on sale of options

[JG EA]

Great summary, I'll keep this since I never got a handle on this subject. Thanks!

[JohnH]

I agree - it's a great summary.
And I plan to keep in on hand also, since I was so obviously confused about the whole subject just yesterday.

[Burke]

Sorry, I guess I was not clear in my question. I understand the difference in taxation issues between the two. I just wanted to know what makes an option an ISO versus a NQSO. In other words, what exactly about the option determines which it is? What is the difference in the characteristics of the two? I have seen both issued by the same company to the same employee.