Exercising a stock option

Am trying to get some tax advice for my son (who asked for it) re: his exercise of a stock option. Several years ago as an incentive to join his present company, he was
given the option to puchase several hundred shares of common stock at what was then about $29/share. He now wishes to exercise the option and immediately sell the stock. Stock is now about $60/share. Since he never paid for the stock in the first place, does he pay tax on the entire $60, or on the $31 difference. I know the capital gains rates changed this year. At what rate will this gain be taxed? Anything else of significance? TIA
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He pays tax on the $31 difference.

Since he's not holding the stock for a year to be taxed as a long term gain, it's ordinary income.
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On Wed, 9 Jan 2008 15:08:48 EST, snipped-for-privacy@iecc.com (John L) wrote:

Thanks for your help. So you are saying that he should have bought the stock, then waited a year before selling it, for it to have been a capital gain event?
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Roy Starrin wrote:

Perhaps. Nonqualified incentive stock options are taxed as ordinary income (the difference between the exercise price and the current value) when they are exercised. So assuming his options are nonqualifed, your son would have the same amount of taxable income whether he sells the stocks or not.
If he exercises the option but does not sell them, and pays the tax, any additional increase in value would be capital gain if he holds them for the required period.
So the only way he could have done better would have been to have exercised the options when the stock had a lower value.
If the options were qualified, there is no tax on exercise. To get long term capital gain treatment he would still have to hold the actual stock, rather than the options, for a year.
Stu
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Roy Starrin wrote:

To be long-term capital gain, yes. It's still a capital gain, just short term if not held for the requisite time (which is >1 year, not just one year, incidentally--one day over is enough, but has to be over). The transaction(s) will still be reported on Sch D, but in the short term section, not the long term.
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And since this was a same day exercise and sale, he should end up with a small short term capital loss, representing the broker's fee or commission.
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ArtKamlet at a o l dot c o m Columbus OH K2PZH

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Arthur Kamlet wrote:

I thought nonqualified stock options (assuming that's what they are) are taxed as ordinary income when exercised, not even short term capital gain.
Stu
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Correct. He gets ordinary income of the difference between the option price and FMV when he exercises the option, but then he ALSO gets a short-term loss due to the fees from the immediate sale.
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Barry Margolin, snipped-for-privacy@alum.mit.edu
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You are both right.
When doing a same day exercise and sale with a NQSO, the Bargain Element, which is the difference between FMV of the stock at time of exercise and the exercise price, is added to taxable wages (and FICA wages) on the W-2 form.
And W-2 Box 12 Code V tells you the amount of the bargain element, but it's already added into the W-2 wages.
So as we can see, the bargain element (the "profit") is going to be treated as earnd income and taxed as ordinary income.
Since it was a same day exercise and sale, a 1099-B will list the sales price, usually the gross sales price.
That sale gets reported on Schedule D Short Term.
The cost basis is the exercise priceplus the taxable bargain element (which is equal to the FMV at exercise) plus the broker's fee. So the ST capital loss on the Sch D is just the broker's fee.
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ArtKamlet at a o l dot c o m Columbus OH K2PZH

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On Wed, 9 Jan 2008 18:18:24 EST, snipped-for-privacy@panix.com (Arthur Kamlet) wrote:

Many thanks to all for the advice. Have sent it on to my son. In fact, I was so impressed, I am about to ask a "Second Question"
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On Jan 9, 12:08pm, snipped-for-privacy@iecc.com (John L) wrote:

In addition to all the other responses, there is also social security, medicare, state tax on the $31. I'm not sure if qualified employee stock options have social security and medicare, but I'm pretty sure non-qualified employee stock options do. The employer has to also pay their share of social security and medicare.
Is there any AMT impact from exercising your options into stock and holding?
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If ISOs there is no FICA tax on the ordinary income rsulting from a disqualifying disposition. An ISO with a same day exercise & sale of course is disqualifying.

AMT could be affected simply because AGI is raised.
If this is an ISO, and not disqualified in the year of exercise, then the bargain element (profit upon exercise) is additional income for tentative minimum tax calculation, and the bargain element is not added to the cost basis for AMT.
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ArtKamlet at a o l dot c o m Columbus OH K2PZH

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On Jan 11, 6:26pm, snipped-for-privacy@panix.com (Arthur Kamlet) wrote:

So the difference between market and strike price at the time of exercise times the number of shares minus commissions gets reported one the AMT form 6251 line 13 ("Exercise of incentive stock options (excess of AMT income over regular t ax income)"). But on form 8801, you get a credit for the AMT tax on stock options because you don't have to report your stock option phantom profit on this form. Is my reasoning correct? And is the AMT credit a refundable credit?
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There is now a refundable credit; that's new.
And remember that when you finally sell the stock, the basis for regular income tax is just the exercise price, while the basis for AMT is the exercise price plus the Bargain Element (what was added to the 6251 in the year of exercise). This produces a smaller gain for AMT than for regular income tax and helps lower AMT and/or produce an AMT credit.
You didn't ask, but only AMT timing issue items may be used to calculate AMT credit. And for most taxpayers -- almost all -- the three timing issues of concern are ISO exercise bargain elements, depreciation, and passive activity differences.
Non-timing issues such as loss of Schedule A deductions or dependency exemptions are permanent and not subject to AMT credit.
Anyway, if you haven't tried this a few times, remember you may be attaching to your tax return both a regular tax and also an AMT version of several forms and schedules, including Schedule D already mntioned, and the passive Activities and depreciation forms.
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ArtKamlet at a o l dot c o m Columbus OH K2PZH

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