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Annotated diagram of Schedule DTax errors can be costly! Don't draw unwanted attention from the IRS. Our Tax Center explains and illustrates the tax rules for sales of company stock, W-2s, withholding, estimated taxes, AMT, and more.


Basics: Exercise


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Articles (Jump to FAQs)

Stock Option Fundamentals (Part 6): Exercise Methods This is premium content

Marilyn Renninger
Exercising stock options is like playing a hand of cards: if your plays are strategic, you'll probably "know when to hold them and when to fold them." But, as always, rules and regulations apply to what you can do.

Stock Option Terms: What You Can Expect This is premium content

Richard Friedman
UPDATES! Get a sense of what you should, and should not, expect in the terms of your stock option grant. A major survey of companies looks at trends in vesting schedules, post-termination exercise rules, and other plan features.

Psychological Factors Affect Your Stock Option Exercise Decisions This is premium content

Professor Steven Huddart
It is tempting to exercise and sell your stock options when your company's stock price hits new highs or becomes worryingly volatile. However, this decision may not be in your best long-term financial interest. This article exames the psychological factors that can, along with economic motives, influence your stock option choices.

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FAQ Table of Contents:


Basics & Rules

How is my stock option's exercise price set? This is premium content

The full board of directors, the compensation committee, or an executive with expressly delegated authority...

How is fair market value (FMV) determined for setting my exercise price? What are common company practices? This is premium content

In most cases, your exercise price for stock options is...

Other than paying the exercise price, what else must I do to exercise an option?

The specific steps vary among companies. You usually first need to make an irrevocable election to exercise...

Do I need to sell my shares at exercise?

The exercise and the sale are separate. Whether you sell the shares at the time you exercise stock options depends on various factors. At exercise, you can usually...

If my options are vested and have not expired or been forfeited, can my company prevent me from exercising them? This is premium content

Perhaps. Your stock plan or grant agreement may provide that the company can refuse to allow exercises if...

Is my employer required by law to give me choices in how I exercise my options? What are the most common methods? This is premium content

Your company has full discretion on which methods to include in the plan document or grant agreement. Surveys show that...

Are there any limitations on when I can exercise my options? This is premium content

You cannot exercise your options unless they are vested. The one exception...

What price is used for the market price to calculate the spread at exercise in a public company? How will I know what it is? This is premium content

No hard and fast rule exists for determining the fair market value for exercise transactions, as long as a company is...

May I exercise unvested options? This is premium content

No; but there is one exception...

Am I entitled to voting rights or any stock dividends paid to shareholders before I exercise? This is premium content

No. Until you exercise a stock option, you do not have the rights of a...

Is there a minimum number of stock options that I must exercise at each exercise? This is premium content

Usually not for public companies. One exception might be...

How many times may I exercise options in a given year? This is premium content

Plans usually do not restrict...

If my stock options are scheduled to expire on a holiday or a weekend, is the last possible exercise date before or after then? This is premium content

You need to check your stock plan's provisions and the procedures/practices followed by your company or any outside stock plan administration firm. Usually...

I have various stock option grants with vested options. Do I need to exercise first my oldest grants or my oldest vested options?

There's no requirement for which vested options you must exercise first. The decision of which options to exercise first is part of your...

What happens if I terminate my employment before an option grant is fully vested?

If your option was granted with a graded vesting schedule, you are allowed to exercise the vested portion of the option grant, but most commonly you forfeit the remainder...

I am an hourly employee. Does my gain from the exercise of options count in computing overtime? This is premium content

This depends on how the grant is structured. A federal law...

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Exercise Methods

Can my employer later add methods of exercise not provided for in the original grant?

Many companies do this because their original plans consider nothing but cash exercises. For example...

What methods may be used to exercise an option?

Check your company's stock plan for the allowed methods and procedures. The most common methods involve...

What forms of exercise notice will my company accept? This is premium content

Review all of your stock plan documents to become familiar with the permitted manners of exercise, and find out...

Will my employer physically deliver shares to me upon exercise of an option? This is premium content

Yes, if you so desire...

What are the expenses, commissions, and fees involved with exercising stock options? This is premium content

These depend on various factors. You need to pay the following when you exercise stock options...

How do I exercise an option for cash? This is premium content

The specific procedures vary (check the details of your stock plan documents). Generally you are required to complete the following steps...

What is a "cashless exercise"? This is premium content

This is the most common type of exercise. When it is permitted by your stock plan, a cashless exercise is an exercise-and-sell transaction in which you do not...

What is the procedure for a cashless exercise/same-day sale? This is premium content

For the transaction to occur, you need to follow the specific procedures detailed by your stock grant agreement and any brokerage firm or transfer agent your company requires you to use. While it is hard to generalize, the process often works as follows...

How soon after an NQSO exercise must the withholding taxes be paid to the IRS? Is the timing different for a cashless exercise? This is premium content

The IRS has set deposit rules companies must follow. With a cashless exercise, the broker essentially sells the shares that underlie the options at the time of exercise. The broker sends the company cash from the sale of your shares that is equal to the amount required for tax...

Does the Sarbanes-Oxley Act outlaw cashless exercises by senior executives and directors? This is premium content

The law seems to leave this matter open. Generally, it prohibits public companies from directly or indirectly making...

What is a "sell-to-cover" exercise? This is premium content

A sell-to-cover exercise is a type of cashless exercise in which the broker sells just enough of the shares from your exercise to cover all the costs. You need to be careful about...

How do I use stock that I own to exercise an option in a stock swap? What is the tax treatment? This is premium content

A "stock swap" or "stock for stock" exercise is a stock option exercise in which the exercise price is paid with shares of company stock you own...

Can I use ISO stock to exercise NQSOs? Is this a disqualifying disposition that eliminates the special tax treatment for ISOs? This is premium content

Yes, you can use ISO stock to exercise NQSOs without disqualifying it, as the...

Must I physically deliver the certificates of the swapped shares to my employer? This is premium content

Not necessarily. Stock option plans that allow stock swaps may permit you to exercise options with already owned shares through a procedure known as...

If I use shares in my possession to exercise an option, must I follow special procedures? This is premium content

Yes. If actual shares are delivered, they must be in transferable form when tendered...

Can I use ESPP shares in a stock-swap exercise of my options? This is premium content

Yes, if your company allows it. When you use your ESPP shares as currency for exercising options, you receive both replacement shares equal to the number you exchanged and the profit shares...

Can I use restricted stock in a stock swap to exercise my options? This is premium content

Not until the restricted stock vests. Then the stock is...

In a stock swap, why does my employer require me to use shares that I have owned for six months or more to exercise an option? This is premium content

Your stock plan and your company's accountants may require this before you can tender shares to cover the exercise price. If shares obtained from the exercise of a stock option are used before...

What is a "net options" exercise? This is premium content

Some companies use "net options" or "net share settlement" to denote exercises in which you return or surrender to the company...

How can I use a promissory note to exercise an option? This is premium content

If your plan or grant agreement permits, you may ask the company to lend you the amount necessary to exercise the stock option...

What are the customary terms of a promissory note used to exercise an option? This is premium content

Important terms concern the interest rate and the type of security for the loan. For tax reasons, a loan from an employer must bear interest at the applicable federal rate ("AFR"), and it must allow the company to sue you if you do not repay the loan...

What is a "transfer agent"? This is premium content

Transfer agents are record keepers hired by public companies to assist in the...

Is there a brokerage commission if I just exercise and hold my shares? This is premium content

Not if you used cash, a company loan, or shares of company stock that you already own. If you engage in a "sell-to-cover" exercise...

What are the different types of sell orders I can place with my option exercise? This is premium content

You can place four types of sell orders, depending on your brokerage firm and company rules...

What are margin loans? Can company stock be used as collateral? This is premium content

Brokers are allowed by Regulation T of the Federal Reserve to lend up to 50% of a stock's market price on the day of the loan...

How can I use a margin loan to exercise my options? Does it defer the taxes? This is premium content

A margin loan allows you to borrow money from a stockbroker by using negotiable securities as collateral. Optionholders can use the borrowing power in stock they will receive to pay for an option exercise when the market price is...

What are the risks of borrowing money from my company to exercise a stock option, to purchase restricted stock, or to pay the taxes at vesting? This is premium content

In a quest to start your one-year capital gains holding period and minimize the amount of ordinary income associated with an award or grant, you may...

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Taxes

When and how is the income at exercise taxed?

The tax treatment depends on the type of stock option. This website has detailed content about tax withholding and reporting in the Tax Center, which includes annotated examples.

Can I rescind a stock option exercise and reverse the tax impact? This is premium content

Only in very limited circumstances, and your company needs to allow the rescission. The company would...

For NQSOs or SARs exercised on the last business day of 2014, or for restricted stock that vests on that day, is the income taxable in 2014 or 2015? This is premium content

All exercises with an exercise date in 2014, and all restricted stock with a vesting date in 2014, will be included in 2014 taxes and on your W-2 for 2014, and will count...

If my company requires me to have a foreign bank or brokerage account because of the stock plan, what do I need to know about the FBAR and FATCA reporting rules? This is premium content

Under the FBAR and FATCA rules, you may have special IRS reporting requirements if you hold assets in a bank outside the US. This FAQ explains the requirements and the severe penalties that the IRS imposes for noncompliance...

When does my holding period for capital gains begin? At exercise or vesting?

The holding period to determine whether a capital gain is long-term or short-term starts on the...

When does my holding period for the special tax rate on dividends begin? At exercise or vesting? This is premium content

The holding period to determine whether a dividend is qualified and thus taxed at a lower rate starts on...

UPDATES! What tax statement will I receive from my broker after a sale of company stock I acquired by stock option exercise, restricted stock vesting, or ESPP purchase? This is premium content

You will need to gather certain information to complete your tax return. The broker will send you IRS Form 1099-B for the proceeds...

Do I always get a Form 1099-B for a same-day-sale cashless exercise? Are there exceptions, and if so how do I report the sale on my tax return? This is premium content

You should almost always receive Form 1099-B. The only exception occurs if certain requirements under IRS Rev. Proc. 2002-50 are met. This revenue procedure allows...

I have underwater stock options that are about to expire unexercised. Can I write these off as some type of loss on my tax return? This is premium content

Wishful thinking! Just as you are not taxed on the value of the options at grant, you may not write off any expired unexercised options, whether underwater or in the money...

If I borrow money to exercise my options, can I deduct the interest payments against dividend income from my company stock? This is premium content

Maybe not. You are probably thinking that you can borrow money, such as with a margin loan, deduct this as an investment interest deduction, and net it against investment income...

My company accelerated the vesting of its outstanding stock options for "accounting reasons" and imposed restrictions on sale. Do I pay extra tax because of the acceleration, or less because I cannot sell the shares when I want? This is premium content

Let's begin with the "accounting reasons." Since January 1, 2006, every US company has had to recognize unvested stock options as...

If I were to sell my stock immediately upon exercise or at vesting, the transaction would violate the insider-trading laws and the laws of short-swing profits under Section 16(b) because I had a purchase within six months of the sale. Would this then delay the date of the tax treatment? This is premium content

The spread at exercise is what matters for the tax calculation...

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Restrictions

Do blackout or lockdown periods exist for stock plans? Are there periods during which you can't exercise options or buy stock in an ESPP? This is premium content

The popular media sometimes confuse the term "blackout" with "lockdown." For stock plans, these terms apply to different...

How do blackout periods affect stock option exercises and the tax treatment? This is premium content

Most companies do not prohibit exercises of stock options during blackout periods (but see an exception). However, you need to be careful about...

Is the date for determining taxes delayed if the stock I receive is not registered with the SEC and I cannot immediately sell it? This is premium content

As the IRS confirmed in Revenue Ruling 2005-48, the tax-measurement date...

Can the exercise of stock options be an insider-trading violation? This is premium content

If you exercise stock options when you know secret stock-price-moving information about your company, the exercise itself is not a violation, according to most experts. However, selling the stock at exercise, as in a cashless exercise/same-day sale, when you know confidential information about the company would almost certainly be considered insider trading. Examples...

How much time do I have for exercising vested stock options after my employment ends? This is premium content

The period for option exercise depends on both your employer's plan design and the reason for your termination. If the options are not exercised by the specified date, they are forfeited. Court cases and survey data show that...

If I leave my company to retire, will I have a longer period to exercise my vested options than I would if I left to take another job? This is premium content

Retirement is a termination of employment under your stock option plan. Under almost all stock option plans, after you terminate employment the plan specifies...

What are common periods that stock plans allow for exercising stock options upon death? This is premium content

Often, stock option plan documents provide a longer exercise period for death than for other terminations of employment. For example...

Can I exercise my options before they are vested and make a timely Section 83(b) election to be taxed on the spread at that point? This is premium content

Generally, stock options are exercisable only when they vest. However, some pre-IPO companies grant options that...

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