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Subject:  Exercising non-qualified options
Date:   Tue, 27 Jun 2006
From:   Mark

I saw in your material that there is no tax benefit for exercising non-qualified stock options and holding the shares. According to an explanation at the Turbo Tax web site, if "you exercise the option to purchase the shares, then you sell them more than a year after the day your purchased them" that you will pay long-term capital gains tax.

Isn't the long-term capital gains tax a tax benefit?

Answer

Date:   05 Jul 2006

Hello Mark,

I'm sorry for the confusion. Remember that when you exercise a non-qualified stock option, you report ordinary income for the excess of the fair market value of the stock received over the option price. That ordinary income is currently taxable (in most cases as additional wages) and is not converted to long-term capital gain by holding the stock for more than one year. Any additional gain from the sale of the stock after holding it more than year will be a long term capital gain, eligible for the lower tax rates that apply to long-term capital gains.

My point is, you would receive the same tax benefit if you simply bought the shares outright without exercising a stock option.

If that is true, the correct question is, would you buy this stock at its current fair market value if you received a cash bonus? For most employees, holding a concentrated position in employer stock is not a wise investment decision. There are situations, like when the employer is preparing a public offering with an expected big increase in value, when it may make sense to take the risk. Just recognize what you're doing.

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.