Question

9. On March 1, 2018, Unicorp granted 1,000 Non-qualified Stock Options to Haley (an employee). The exercise price on the shares was $2 per share. On December 31, 2018, Jim exercised all of her stock options when the market price per share was $10. What is the basis of her stock, and what amount should be included on her Form W-2 as wage income in 2018?

Answer 1

For tax purposes, an employee stock options are classified as either Incentive stock options (ISO's) or Non-Qualified stock options (NSO's).

Incentive stock options (ISO's):

• Also known as Qualified stock options.
• An Employee (or any other individual) who possess these type of stock options has a tax benefit that upon exercising the option to purchase the stock at the exercise price or grant price, employee does not has to pay the ordinary income tax on the income (which is the difference between the exercise price and the fair market value of the shares).

Non-Qualified stock options (NSO's)

• In simple terms, a Non - Qualified stock option is the one that is taxable at the ordinary income tax rate when the holder of the options exercised his right to purchase the stock at the exercise price or agreed price.
• The taxable income is the difference between the exercise price and the fair market value of the shares (on the date of exercise).
• Employer must report this difference in From W-2 as an addition to the actual wages in the year employees exercised their options.
• This difference is usually called as compensation income and IRS treats this compensation income just like the salary or wages.

Basis of stock

Cost basis is different for both Incentive stock options (ISO's) and Non-Qualified stock options (NSO's).

• For Incentive stock options (ISO's), Cost basis is the exercise price.
• For Non-Qualified stock options (NSO's), Cost basis is the sum of exercise price and compensation element that is included in the W-2 form as an addition to the actual wages.

Therefore, in order to calculate the basis of the stock, first we need to calculate the amount that should be included in the Form W-2.

1. Calculation of the amount that should be included in the Form W-2

Number of Stock options = 1,000

Exercise price per shares = $2 per share

Market price per share = $10 per share

Total exercise price = 1,000 x $2 = $2,000

Toal market value of the share = 1,000 x $10 = $10,000

Amount that should be reported in Form W-2 = Total Market value - Exercise price of the stock option

Amount that should be included in the Form W-2 = $10,000 - $2,000 = $8,000

2. Calculation of basis of stock

As explained earlier,

Cost basis of stock = Exercise price + Amount reported in Form W-2 when exercised.

Cost basis of stock = $2,000 + $8,000 = $10,000

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