Incentive stock options (ISO) are stock options granted to employees by the employer's corporation that are qualified for special tax treatment under IRS code Sec.422. You don't report income or pay tax when you receive the option. You don't report income but may have to pay alternative minimum tax (AMT) for the tax year that you exercise the option. Depend on how long you hold the shares, you report compensation income or gain/loss from disposal when you sell or dispose the shares. Part I of this post walks you through the steps to calculate and report alternative minimum tax (AMT) adjustment for the year you exercise the ISO. Part II goes through steps to report the sale of stock acquired through incentive stock options.
Part I: Calculate and report alternative minimum tax (AMT) adjustment for the year you exercise the ISO.
Note: You don't need to make the adjustment if you disposed the stock in the same year you exercised the option.
Step 1: Calculate alternative minimum tax (AMT) adjustment.
If you exercised ISO, you should receive Form 3921, Exercise of an Incentive Stock Option Under Section 422(b), or a statement from your employer at the end of January or early February following the year you exercised the option. You can use the information provided on Form 3921 to calculate the AMT adjustment as the example below.
Step 2: Report alternative minimum tax (AMT) adjustment.
1. Enter this adjustment on line 14 of Form 6251, Alternative Minimum Tax—Individuals.
2. Increase AMT cost basis of the stock by the amount of AMT adjustment.
Part II: Report the sale of stock acquired through incentive stock options.
Step 1: Collect information needed for reporting.
1. Form W-2. You will need to check if your employer included the ordinary income on your W-2, box 1 if you sold the stock before you satisfy the holding period requirement.
2. Form 3921, Exercise of an Incentive Stock Option Under Section 422(b), or a statement, from your employer.
3. Form 1099-B.This form reports proceeds from stock sale.
Step 2: Determine if your stock holding period was satisfied.
You satisfy the holding period requirement if:
- The stock was granted to you for more than two years and you hold the stock for more than one year after the stock was transferred to you.
- or you sold the stock to comply with conflict of interest requirements.
Go to Step 3-1 if you satisfy the holding period requirement.
Go to Step 3-2 if you don't satisfy the holding period requirement.
Step 3-1: Calculate gain/loss from the sale - Holding period requirement was satisfied.
Use information you collected from Step 1 to calculate gain or loss from the sale.
Since you satisfied the holding period requirement, all you gain or loss are capital gain or loss, you can go to Step 5 to report your capital gain or loss.
Step 3-2: Calculate gain/loss from sale - Holding period requirement was not satisfied.
Use information you collected from Step 1 to calculated gain or loss from the sale. Example 2 and 3 below present different tax treatment for gain or loss from sale. Use the example that applies to you.
If you have gain, go to Step 4.
If you have loss, go to Step 5.
Step 4: Check W-2 or related document from your employer to see if your employer included the ordinary income calculated on Step 3 as wage in box 1.
If the ordinary income is not included in box 1 of your W-2 form, you must report it as wage on Form 1040, line 7 and add the ordinary income to the cost basis of the stock sold.
If the ordinary income is included in box 1 of your W-2 form, you need to add the ordinary income to the cost basis of the stock sold so that your will not be taxed twice on this income.
You can use the example below as reference to check your W-2.
Step 5: Report the capital gain/loss calculated on Step 3 on Form 8949 or Schedule D.
Report the gain/loss on Part I of Form 8949 if you hold the stock less than one year, or Part II of Form 8949 if you hold the stock more than one year.
Step 6: Calculate and report the capital gain/loss adjustment for AMT purpose.
For more information about incentive stock options, please see IRS Publication 525 and Code Section 422.
Related Article(s)
How to Report Sale of Stock Acquired Through Employee Stock Purchase Plan on Your Tax Return
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