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This is about an Incentive Stock Option (ISO) plan that

allows you to pay to...
This is about an Incentive Stock Option (ISO) plan that allows you to pay to exercise vested options with other vested options.Example: after one year, 20,000 options have vested, all of which have a $3 strike price. There are two ways to pay to exercise these vested options:Option 1: You can opt to pay $60,000 (20,000 * $3) in cash to exercise all 20,000 of the vested optionsOption 2: You can opt to exercise 10,000 of your vested options without laying out any actual cash; instead, you can pay to exercise those 10,000 vested options using the other 10,000 vested optionsMy question for you is what would the tax implications be for Option #2 above? Would you be taxed as if you exercised all 20,000 shares? Or just 10,000?
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Answered in 55 minutes by:
10/13/2017
Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,677
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
Verified

HI, MY NAME’S LANE - I hold a law degree (J.D.), with concentration in Tax Law, Estate law & Corporate law, an MBA in finance, a BBA, and CFP & CRPS (Chartered Retirement Plans Specialist) designations, as well - I’ve been providing financial, Social Security/Medicare, estate, corporate, non-profit, and tax advice 1986.

...

You are only taxed on the options that you exercise (regardless of whether it's 20, 10 or 1). The strategy you mention is exactly what happens when one exercises less that all of the options they own.

...

In order to calculate the tax treatment of ISOs, you'll need to know the following:

...

  • Grant date: the date the ISOs were granted to the employee

...

  • Strike price: the cost to purchase a share of stock

...

  • Exercise date: the date on which you exercised your option and purchased shares

...

  • Selling price: the gross amount received from selling the stock

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(And of course we need to know the selling date)

...

A qualifying disposition of an ISO is taxed as a capital gain at the long-term capital gains tax rates on the difference between the selling price and the cost of the option.

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A disqualifying or nonqualifying disposition of ISO shares is any disposition other than a qualifying disposition. Disqualifying ISO dispositions are taxed in two ways: there will be compensation income (subject to ordinary income rates) and capital gain or loss (subject to the short-term or long-term capital gains rates).

...

    If you sell the ISO at a profit, then your compensation income is the spread between the stock's fair market value when you exercised the option and the option's strike price....Any profit above compensation income is capital gain....If you sell the ISO shares at a loss, the entire amount is a capital loss and there's no compensation income to report.
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Customer reply replied 9 months ago
if I use 10k vested options to pay to exercise another 10k of vested options then I only pay taxes as if I exercised 10k vested options?Are you positive about this? There aren't any tax implications related to the 10k options that I used to pay for the other 10k options?

There are actually five ways (categories) that the exercise can fall into (in terms of taxation)

...

With an ISO, you can:

  1. Exercise your option to purchase the shares and hold them.
  2. Exercise your option to purchase the shares, then sell them any time within the same year.
  3. Exercise your option to purchase the shares and sell them after less than 12 months, but during the following calendar year.
  4. Sell shares at least one year and a day after you purchased them, but less than two years since your original grant date.
  5. Sell shares at least one year and a day after you purchased them, and at least two years since the original grant date.

...

Each transaction has different tax implications. The first and last are the most favorable. The time at which you sell determines how the proceeds are taxed.

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I don't understand what you mean by USE

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Customer reply replied 9 months ago
I think you're misunderstanding my question.The option agreement allows the vested option holder to pay to exercise vested options in two ways:1 - Just pay the exercise price with cash2 - Pay the exercise price with other optionsFor payment method 2 from above, if I were to own 20,000 vested options, I'd be able to exercise and thus own 10,000 without laying out any cash (I'd be paying for the 10,000 with the other 10,000).
Customer reply replied 9 months ago
My question is, if I were to use vested options to pay to exercise other vested options, what would the tax implications be? Would I only be taxed on the options that I end up owning? Or would I also get taxed for the options that I used to pay to exercise the ones that I end up owning?

You have to break this down into exercise (which means you now own the stock, and then selling the stock)

...

If you exercise your option to purchase the shares, and then selling those shares at the same time (ANYTIME within the same calendar year) here's how it works.

...

Lets say that the facts are as follows:

Grant date

12/31/2015

Exercise date

06/30/2016

Exercise price

$20

Sale date

06/30/2016

Sale price

$45

Number of shares

100

Bargain element

$2,500

...

The bargain element is the difference between the exercise price and the market price on the day you exercised the options and purchased the stock ($45 - $20 = $25 x 100 shares = $2,500).

...

This amount should already be included in the total wages reported in Box 1 of your 2016 Form W-2 because this is a disqualifying sale (meaning you are disqualified from taking it as a capital gain and being taxed at the lower capital gains rate because you sold the shares less than a year after exercising the option).

...

If this amount is not included in Box 1 of Form W-2, (your company got it wrong, and they many times do), add it to the amount you're reporting on your 2016 Form 1040, line 7

...

Then report the sale on your 2016 Schedule D, Part I as a short-term sale. The sale is short-term because not more than one year passed between the date you acquired the actual stock and the date you sold it. For reporting purposes on Schedule D:

The date acquired is 6/30/2016The date sold is also 6/30/2016The cost basis is $4,500.This is the actual price paid per share times the number of shares ($20 x 100 = $2,000), plus any amounts reported as compensation income on your 2016 tax return ($2,500)The sales price is $4,500 ($45 x 100 shares). This should match the gross amount shown on your 2016 Form 1099-B you receive from your broker after the end of the year....You end up reporting no gain or loss on the stock sale transaction itself, but the $2,500 overall profit will be taxed at your ordinary tax rate. Because you exercised the options and sold the stock in the same year, you do not need to make an adjustment for Alternative Minimum Tax purposes.
Lane
Lane, JD, CFP, MBA, CRPS
Category: Capital Gains and Losses
Satisfied Customers: 14,677
Experience: Have been providing Financial and Tax advice for 30 years.Concentration in Corporations, Estate, Income Tax and Business Planning
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