When is ISO income taxed as capital gains?

October 17, 2011

Date:   Tue, 26 Mar 2008
From:   Paula

I wish to use non-qualified stock options that I own to fund an LLC business. Is it possible to transfer the stock option ownership to my LLC for favorable taxation so that, when it is sold, the gain is taxed at the corporate rate?


Date:   14 Mar 2008

Hello Paula,

Usually LLCs are not taxed as corporations. When the LLC is owned by a single member, it is disregarded for income tax reporting and income of the LLC is reported on the income tax return of the member.

LLCs may elect to be taxed as corporations.

The IRS eliminated what was perceived to be a loophole that stops ordinary income to the optionee when the option is sold or otherwise disposed to a person or entity related to the employee or service provider on or after July 2, 2003. (Treasury Regulations Section 1.83-7.)

This means that when the “corporate” LLC exercises the non- qualified stock option, the income will be taxable to you.

Further, the sale of a NQO to a related person for a consideration that includes a deferred payment of money or property is a listed transaction, requiring special disclosure on an income tax return. (Treasury Notice 2003-47, 2003-2 C.B. 132.)

Needless to say, this is not a good strategy.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options – Executive Tax and Financial Planning Strategies.

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