Statutory Stock Options - IRS Form 3921 - John R. Dundon II, Enrolled Agent
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Statutory Stock Options – IRS Form 3921

The Perturbing New Treatment of Patents Under the Tax Cut & Jobs Act (TCJA)

Statutory Stock Options – IRS Form 3921

This post address Statutory Stock Options – IRS Form 3921.

There are essentially two kinds of stock options, statutory and non-statutory.  If you exercise an Incentive Stock Option during 2010, you should have received IRS Form 3921, Exercise of an Incentive Stock Option Under Section 422(b), or a statement, from the corporation for each transfer made during 2010. The corporation should have provided you with the form by January 31, 2011. Today I write about Statutory Stock Options of which there are essentially two types:

  1. Incentive stock options (ISOs), and
  2. Options granted under employee stock purchase plans.

For either kind of statutory stock option above, you must be an employee of the company granting the option, or a related company, at all times during the period beginning on the date the option is granted and ending 3 months before the date you exercise the option (for an incentive stock option, 1 year before if you are disabled). Also, the option must be nontransferable except at death. If you do not meet the employment requirements, or you receive a transferable option, your option is a non-statutory stock option.  I’ll blog about non-statutory stock options in a future post.

Facts about tax treatment of Statutory Incentive Stock Options (ISO):

  1. Grant of option. If you receive a statutory stock option, do not include any amount in your income when the option is granted.
  2. Exercise of option. If you exercise a statutory stock option, do not include any amount in income when you exercise the option.
  3. Sale of the stock. You have taxable income or a deductible loss when you sell the stock that you bought by exercising the option. Your income or loss is the difference between the amount you paid for the stock (the option price) and the amount you receive when you sell it. You generally treat this amount as capital gain or loss and report it on Schedule D (Form 1040) for the year of the sale.
  4. You may have ordinary income for the year that you sell or otherwise dispose of the stock in either of the following situations.
    1. You do not satisfy the holding period requirement. You satisfy the holding period requirement if you do not sell the stock until the end of the later of the 1-year period after the stock was transferred to you or the 2-year period after the option was granted. However, you are considered to satisfy the holding period requirement if you sold the stock to comply with conflict-of-interest requirements.
    2. You satisfy the conditions described under Option granted at a discount, under Employee stock purchase plan.
  5. If you sell stock acquired by exercising an ISO, do not satisfy the holding period requirement, and have a gain from the sale, the gain is ordinary income up to the amount by which the stock’s fair market value when you exercised the option exceeded the option price. Report your ordinary income as wages on Form 1040, line 7, for the year of the sale.
  6. Any excess gain is capital gain. If you have a loss from the sale, it is a capital loss and you do not have any ordinary income. Report the capital gain or loss on Schedule D (Form 1040). In determining capital gain or loss, your basis is the amount you paid when you exercised the option plus the amount reported as wages.
  7. Calculating Alternative Minimum Tax for ISO’s exercised  (converted from options to actual stock) and the stock is subsequently not sold in the year the options were exercised adds a degree of complexity to the tax implications that I will blog abut tomorrow.

Facts about tax treatment of options granted under employee stock purchase plans.:

  1. If you sold stock acquired by exercising an option granted under an employee stock purchase plan, you need to determine if you satisfied the holding period requirement.
  2. You satisfy the holding period requirement, determine your ordinary income as follows.
    1. Your basis is equal to the option price at the time you exercised your option and acquired the stock. The timing and amount of pay period deductions do not affect your basis.
    2. Your holding period for the property you acquire when you exercise an option begins on the day after you exercise the option.

Examples from IRS Publication 525 – Taxable and Non Taxable Income:

Example 1: XYZ Company has an employee stock purchase plan. The option price is the lower of the stock price at the time the option is granted or at the time the option is exercised. The value of the stock when the option was granted was $25. XYZ deducts $5 from A’s pay every week for 48 weeks (total = $240 ($5 × 48)). The value of the stock when the option is exercised is $20. A receives 12 shares of XYZ stock ($240 ÷ $20). A’s holding period for all 12 shares begins the day after the option is exercised, even though the money used to purchase the shares was deducted from A’s pay on 48 separate days. A’s basis in each share is $20.
Option granted at a discount. If, at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the fair market value of the share, and you dispose of the share after meeting the holding period requirement, or you die while owning the share, you must include in your income as compensation, the lesser of:

  • The excess of the fair market value of the share at the time the option was granted over the option price, or
  • The excess of the fair market value of the share at the time of the disposition or death over the amount paid for the share under the option.For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is figured as if the option had been exercised at the time it was granted.

Any excess gain is capital gain. If you have a loss from the sale, it is a capital loss, and you do not have any ordinary income.

Example 2: Your employer, Y Corporation, granted you an option under its employee stock purchase plan to buy 100 shares of stock of Y Corporation for $20 a share at a time when the stock had a value of $22 a share. Eighteen months later, when the value of the stock was $23 a share, you exercised the option, and 14 months after that you sold your stock for $30 a share. In the year of sale, you must report as wages the difference between the option price ($20) and the value at the time the option was granted ($22). The rest of your gain ($8 per share) is capital gain, figured as follows:

Selling price ($30 × 100 shares) $ 3,000
Purchase price (option price)
($20 × 100 shares) −2,000
Gain $ 1,000
Amount reported as wages
[($22 × 100 shares) − $2,000] − 200
Amount reported as capital gain $ 800

Holding period requirement not satisfied. If you do not satisfy the holding period requirement, your ordinary income is the amount by which the stock’s fair market value when you exercised the option exceeded the option price. This ordinary income is not limited to your gain from the sale of the stock. Increase your basis in the stock by the amount of this ordinary income. The difference between your increased basis and the selling price of the stock is a capital gain or loss.

Example 3: The facts are the same as in the previous example, except that you sold the stock only 6 months after you exercised the option. You did not satisfy the holding period requirement, so you must report $300 as wages and $700 as capital gain, figured as follows:

Selling price ($30 × 100 shares) $3,000
Purchase price (option price)
($20 × 100 shares) −2,000
Gain $1,000
Amount reported as wages
[($23 × 100 shares) − $2,000] − 300
Amount reported as capital gain
[$3,000 – ($2,000 + $300)] $700

Example 4: Your employer, X Corporation, granted you an ISO on March 12, 2008, to buy 100 shares of X Corporation stock at $10 a share, its fair market value at the time. You exercised the option on January 5, 2009, when the stock was selling on the open market for $12 a share. On January 26, 2010, you sold the stock for $15 a share. Although you held the stock for more than a year, less than 2 years had passed from the time you were granted the option. In 2010, you must report the difference between the option price ($10) and the value of the stock when you exercised the option ($12) as wages. The rest of your gain is capital gain, figured as follows:

Selling price ($15 × 100 shares) $ 1,500
Purchase price ($10 × 100 shares) −1,000
Gain $ 500
Amount reported as wages
[($12 × 100 shares) − $1,000] − 200
Amount reported as capital gain $ 300




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