How to Report Stock Options to the IRS

How you report stock options on your taxes depends on whether they are qualified.

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Stock options let you purchase shares at a specified price, no matter what the market price is on that day. The price is set on the date the company grants the option. The tax treatment of your option depends on whether it is considered an incentive stock option or a non-qualified stock option. Incentive stock options must be granted under a written option agreement and are only available to employees of the company. Non-qualified stock option may be given to consultants, vendors and other independent contractors.

Step 1

Exercise your option to purchase shares of the company's stock. You have no taxes to report until you exercise the option. If you have an incentive stock option, you don't have to pay any taxes on it until you sell the shares. Non-qualified stock options become part of your ordinary income when exercised. The difference in the market price and the exercise price is already added into Box 1 of your W-2. List this amount on line 7 on Form 1040.

Step 2

Determine whether any sales are qualifying or disqualifying dispositions. To qualify for capital gains tax treatment, you must hold incentive stock options shares for at least one year after exercise and two years after the grant date. If you sell your stock sooner than that, it is a disqualifying disposition, and any gains will be taxed at the ordinary income rate. These disqualifying dispositions will be included in your wage totals in box 1 of your W-2. Report any disqualifying dispositions on line 7 of Form 1040.

Step 3

List each qualifying disposition on a separate line of Part I or II of Schedule D, depending on whether it was a short-term holding or a long-term holding. Shares you sold less than one year after purchase are considered short-term transactions and must be listed in Part I. Use Part II to report your long-term transactions. List the number of shares sold, the dates of purchase and sale, your cost basis, the sale price, and your gain or loss on the sale. The cost basis is the value of the stock on the exercise date. Total each column and complete the tax worksheet to determine your capital gains tax or capital loss deduction.