TaxConnections Picture - Letter U“U” is for unqualified options.  Does this mean the options are not qualified, but not qualified for what?  They don’t qualify for the incentive stock option treatment.  Unqualified or non-qualified stock options result in taxable income to the recipient when they are exercised.  If the stock is worth $50 a share and the option is to purchase at $32 a share, then a gain of $18 per share is recognized when the option is exercised.  These are relatively easy to track and simple to account for because the company can deduct the value ($18 per share) that is income to the taxpayer.

The incentive stock options or qualified stock options are a bit more complicated.  There is no income on the grant date or the exercise date of the option, but when the stock is eventually sold it will qualify for capital gains.  That sounds great, but of course there is an important detail.  On the exercise date, the FMV less the option price is an AMT adjustment for the individual.  This can cause a huge amount of AMT which is only reversed when the stock is sold.  The need for cash to pay the AMT tax at least partially offsets the benefits of the capital gain treatment, so keep an eye out for that.

Taxes A to Z – still randomly meandering through tax topics, but at least for 26 posts in an alphabetical order.