Stock Options & The Basis of Added Shares

Shares of stock you hold for investment purposes are taxed under the capital gain and loss rules when they're sold. You can't calculate your gain or loss unless you know what your tax basis -- cost of acquiring the stock -- in the shares is. But if you purchased additional shares by exercising a stock option, figuring out the basis in the added shares you obtain isn't as straightforward as just adding together your costs.

Receipt of Stock Options

A stock option gives you the right to purchase shares in a corporation at a specified price, regardless of what the market price of the shares are at the time of exercising the option. The receipt of stock options usually isn't a taxable event for most people, but it can be under certain circumstances, such as when you can choose to take cash or property in lieu of the options, for example.

Taxable Stock Options

If you have to include the stock options as income when they're received, your basis in the options contract is its fair market value -- the price you could sell the options for. This fair market value is also the amount to treat as income on your tax return. When you exercise the options and acquire additional shares of stock, the basis of the added shares is equal to your basis in the stock options plus the price you pay for the shares.

Tax-Free Stock Options

The tax-free stock options you receive, such as those your employer grants you as an incentive or through an employee stock purchase plan, have a tax basis of zero. This means that when you exercise these options, your basis in the new or added shares is the exercise price -- the price the option lets you buy the shares for.

Basis of Old Shares

When a stock option isn't taxable, it doesn't affect the basis of the added shares, but it may for your old shares. If at the time you receive the stock option, its fair market value is 15 percent or more of the the market price of the shares you already own, you must allocate the basis you have in them between the old stock and the stock options. You do this by dividing the old stock's market value on the day you receive the options by the sum of this market value plus the value of the options. You then multiply the result by your total basis in the old shares to arrive at the new basis amount for old shares.

Value Less than 15 Percent

If the total value of your options is less than 15 percent of the total value of your old shares, the basis of each additional share you acquire with the option is still the exercise price. But in this case, you don't have to adjust the basis of your old shares unless you want to. If you do, the Internal Revenue Service requires you to attach an explanatory statement to your tax return.

About the Author

Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.

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