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Subject:   tax implications of a person deciding to exercise and hold
Date:   Thu, 1 Feb 2001
From:   David

I understand that when a person has non-qualified stock options, they are taxed when they exercise the options. And that for this reason, most people sell the shares when they exercise them. What are the tax implications of a person deciding to exercise and hold, however?

Would they be taxed a second time if, say, they hold the shares for a year during which the stock price doubles (of loses half its value)?

Thanks,

David

Answer

Date:   9 Feb 2001

Hello David,

When you hold the stock, you are still required to pay the tax on the option exercise.

Your employer should have withheld income taxes relating to the exercise and included the ordinary income in your W-2 wages.

You increase the tax basis (cost for determining gain or loss) of the stock for the ordinary income reported for the exercise.

The holding period for the stock generally starts from the date of exercise of the option.

If you report ordinary income for the exercise and a capital loss for the sale of the stock, you have converted ordinary income to a capital loss. Not a very happy exchange.

Deductions for capital losses are limited to the amount of capital gains plus $3,000. Any excess capital loss is carried forward to succeeding tax years.

Good luck!

Mike Gray

For more information about non-qualified stock options, request our free report, Non-Qualified Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.