NQSOs: Taxes

Capital gain is income that arises from the sale of a capital asset. Gain from the sale of securities held for investment, such as shares acquired from stock compensation, is a type of capital gain.

Tax Rates On Capital Gains

The taxation of capital gains changed at the start of 2013.

• For stock sales that were made before the end of 2012, the tax rate on long-term capital gain is 15% (but 0% for taxpayers in the 10% and 15% income tax brackets).
• With effect from January 1, 2013, the top rate of tax on long-term capital gain is 20% (under the American Taxpayer Relief Act of 2012). This highest rate applies to single filers with yearly taxable income of more than $400,000 and to married joint filers with yearly taxable income of more than $450,000. For people with less yearly taxable income, the capital gains rate remains 15%, except for taxpayers in the 10% or 15% income tax bracket, whose capital gains rate is still 0%.
• Short-term capital gain is taxed at ordinary income rates.
• With effect from January 1, 2013, a Medicare surtax of 3.8% applies to investment income, including capital gains, for people with annual modified adjusted gross income of more than $200,000 (more than $250,000 for married joint filers). This essentially raises the top rate on capital gains to 23.8%.

Alert: Given the income thresholds that trigger higher capital gains rates, be aware that income from stock compensation can increase not only your income tax rate for that tax year but also your capital gains rate.

Tax Rules

The taxation of capital gain from the sale of stock depends on how long the asset is held, and additional rules apply to incentive stock options (ISOs). Capital gains may be short-term (from securities held 12 months or less) or long-term (from securities held more than 12 months). To calculate the holding period, start with the day after your acquisition date and stop counting on the day when you sell the shares.

Capital losses are used to offset capital gains to establish a net position for tax purposes. Only $3,000 of net capital losses can be deducted in any one year against ordinary income, and the remaining balance is carried over to future years indefinitely. For additional details on the tax rules, and for annotated examples of tax return reporting for company stock sales, visit the Tax Center.

Tax Returns

You must file Form 8949 and Schedule D with your federal Form 1040 tax return for any tax year in which you have sold stock. You must file these regardless of whether you have a gain and even if you sold option stock immediately at exercise (i.e. cashless exercise, same-day sale) or if you sold restricted stock at vesting. On your tax return, you report the exercise date (vesting date for restricted stock) as your purchase date, even though your holding period does not begin until the following day. For details, see the section Reporting Company Stock Sales in this website's Tax Center.

Further Reading

As articles and FAQs in the ISO section and the Tax Center explain in detail, with plenty of examples, the calculation of capital gains for ISOs is more complex than it is for NQSOs. For instance, if you exercise ISOs and sell the stock within one year after exercise (i.e. disqualifying disposition) when the market price is lower than it was at exercise (but still above the exercise price), your full gain is ordinary income. In addition, if you pay alternative minimum tax (AMT) on the exercise of ISO stock that you hold, your capital gains calculation when you sell will differ for AMT and ordinary income tax.