Taxation of Incentive Stock Options

The incentive stock options or shortly known as ISOs, are the corporate benefits that enable employees to purchase the stock of the company they’re working for at a discounted price. 

Since the way the stocks are acquired is different from buying stocks at an exchange, many questions how taxation work with ISOs. There is an easy explanation for this. This article will explain how incentive stock options are taxed when sold.

Profit or loss

For something to be taxed, you need to profit from it. If no profit is made after selling a stock, it doesn’t really go with taxes. That said, to see how you’re going to get taxed, you must’ve made a profit in the first place.

ISO capital gains

There is no difference in how taxation works for capital gains from purchasing a stock at an exchange sold later for profit and incentive stock options. You will pay either capital gains tax, or the profit made will count towards your ordinary income. 

In a way, this brings us to how capital gains rather than how incentive stock options are taxed. From an investor’s standpoint, you won’t pay capital gains tax if you sell the stock obtained within a year. Instead, the profit made will be added to your gross income. If you sell the stock a year after holding it, though, it will be taxed as capital gains, and the rate will depend on your income. Learn more about capital gains tax.

This is all assuming that you sell the stock for a profit. For example, if you bought 100 shares of the company you’re working at for $50 per share, that means you invested $5,000. Suppose the stock price went up to $75, and you sold all of your shares. That will bring you a net income of $2,500. Again, if you sell it within a year, that profit – $2,500 – will count towards your gross income, and you’ll pay taxes accordingly. If held for more than a year, it will be taxed as capital gains. It’s as simple as that.

The bottom line is that there is no difference between buying stock from an exchange, then selling for a profit and buying ISO, and selling it for a profit. As far as the Internal Revenue Service is concerned, the profit made from selling a stock is a profit that you’ll pay taxes.

Incentive stock option losses

The same as taxation, you can deduct your losses from incentive stock options. So, the general rules apply, such as it must be realized as you can’t deduct unrealized capital losses. 

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