Incentive Stock Options (2024)

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Written by a TurboTax Expert • Reviewed by a TurboTax CPA

Updated for Tax Year 2022 • December 1, 2022 08:25 AM

OVERVIEW

Some employers use Incentive Stock Options (ISOs) as a way to attract and retain employees. While ISOs can offer a valuable opportunity to participate in your company's growth and profits, there are tax implications you should be aware of. We'll help you understand ISOs and fill you in on important timetables that affect your tax liability so you can optimize the value of your ISOs.

TABLE OF CONTENTS

What are Incentive Stock Options?
Why are Incentive Stock Options more favorable tax-wise?
How transactions affect your taxes

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What are Incentive Stock Options?

A stock option grants you the right to purchase a certain number of shares of stock at an established price. There are two types of stock options—Incentive Stock Options (ISOs) and Non-qualified Stock Options (NSOs)—and they are treated very differently for tax purposes. In most cases, Incentive Stock Options provide more favorable tax treatment than Non-qualified Stock Options.

If you have been granted stock options, make sure you know which type of options you received. If you are not sure, take a look at your option agreement or ask your employer. The type of options should be clearly identified in the agreement.

Why are Incentive Stock Options more favorable tax-wise?

When you exercise Incentive Stock Options, you buy the stock at a pre-established price, which could be well below actual market value. The advantage of an ISO is you do not have to report income when you receive a stock option grant or when you exercise that option.

You report the taxable income only when you sell the stock. And, depending on how long you own the stock, that income could be taxed at capital gain rates ranging from 0% to 23.8% (for sales in 2022)—typically a lot lower than your regular income tax rate.

With ISOs, your taxes depend on the dates of the transactions (that is, when you exercise the options to buy the stock and when you sell the stock).
The price break between the grant price you pay and the fair market value on the day you exercise the options to buy the stock is known as the bargain element.
There is a catch with Incentive Stock Options, however: you do have to report that bargain element as taxable compensation for Alternative Minimum Tax (AMT) purposes in the year you exercise the options (unless you sell the stock in the same year). We'll explain more about the AMT later.

With Non-qualified Stock Options, you must report the price break as taxable compensation in the year you exercise your options, and it's taxed at your regular income tax rate, which in 2022 can range from 10% to 37%.

How transactions affect your taxes

Incentive Stock Option transactions fall into five possible categories, each of which may get taxed a little differently.

With an ISO, you can:

Exercise your option to purchase the shares and hold them.
Exercise your option to purchase the shares, then sell them any timewithin the same year.
Exercise your option to purchase the shares and sellthem after 12 months or less, but during the following calendar year.
Sell shares at least one year and a day after you purchased them, but less than two years since your original grant date.
Sell shares at least one year and a day after you purchased them, and at least two years since the original grant date.

Each transaction has different tax implications. The first and last are the most favorable. The time at which you sell determines how the proceeds are taxed.

If you can wait at least a year and a day after you purchase the stocks, and at least two years after you were granted the option to sell the stocks (as described in item 5 above), any profit on the sale is treated as a long-term capital gain, so it is taxed at a lower rate than your regular income. (Your profit is the difference between the bargain price you pay for the stock, and the market price that you sell it for.)

This is the most favorable tax treatment because long-term capital gains recognized in 2022 are taxed at a maximum 23.8% (or 0 if you're in the 10% or 15% income tax brackets) compared to ordinary income tax rates which may be as high as 37% in 2022.
Sales that meet these one- and two-year time limits are called "qualifying dispositions," because they qualify for favorable tax treatment.
No compensation is reported to you on your Form W-2, so you do not have to pay taxes on the transaction as ordinary income at your regular tax rate.

Now, if you sell the shares before they meet the criteria for favorable capital gains treatment, the sales are considered "disqualifying dispositions," and you may end up paying taxes on part of the proceeds of the sale at your ordinary income tax rate, which could be as high as 37% in 2022.

When you sell the stock two years or less from the offering date, known as the "grant date," the transaction is a disqualifying disposition.
Or if you sell the sharesone year or less from the "exercise date," which is when you purchase the stock, thatis also considered a disqualifying disposition.
Inboth cases,the compensation should be reported on your Form W-2.

The amount reported on your Form W-2 is the bargain element, which is the difference between what you paid for the stock and its fair market value on the day you bought it. But if your bargain element is more than your actual gain from the sale of the stock, then you report as compensation theamount of the actual gain. The reported compensation is taxed as ordinary income.

1. Exercise your option to purchase the shares and hold them

Grant date	12/31/2021
Exercise date	6/30/2022
Exercise price	$25
Sale date	Not sold yet
Market price on 6/30/2022	$45
Number of shares	100
Bargain element	$2,000

You do not report anything on your 2022Schedule D (Capital Gains and Losses) because you have not yet sold the stock. Your employer will not include any compensation related to your options on your 2022 Form W-2 either.

You will have to make an adjustment for the Alternative Minimum Tax (AMT) that equals the bargain element, which is $2,000:

$45 Market Price - $25 Exercise Price = $20
$20 x 100 shares = $2,000 Bargain Element
Report this amount on your 2022Form 6251.

2. Exercise your option to purchase the shares, and then sell those shares within the same calendar year

Grant date	12/31/2021
Exercise date	06/30/2022
Exercise price	$20
Sale date	06/30/2022
Sale price	$45
Number of shares	100
Bargain element	$2,500

The bargain element is the difference between the exercise price and the market price on the day you exercised the options and purchased the stock.

$45 Market Price - $20 Exercise Price = $25
$25 x 100 shares = $2,500 Bargain Element

This amount should already be included in the total wages reported in Box 1 of your 2022 Form W-2 because this is a "disqualifying sale." This means you are disqualified from taking it as a capital gain and being taxed at the lower capital gains rate because you sold the shares within a year or less after exercising the option. If this amount is not included in Box 1 of Form W-2, add it as "Other Income" on your Form 1040.

Report the sale on your 2022 Schedule D, Part I as a short-term sale. The sale is short-term because not more than one year passed between the date you acquired the actual stock and the date you sold it.

For reporting purposes on Schedule D:

The date acquired is 6/30/2022.
The date sold is also 6/30/2022.
The cost basis is $4,500. This is the actual price paid per share times the number of shares ($20 x 100 = $2,000), plus any amounts reported as compensation income on your 2022 tax return ($2,500).
The sales price is $4,500 ($45 x 100 shares). This should match the gross amount shown on your 2022Form 1099-B you receive from your broker after the end of the year.

You end up reporting no gain or loss on the stock sale transaction itself, but the $2,500 overall profit will be taxed at your ordinary tax rate. Because you exercised the options and sold the stock in the same year, you do not need to make an adjustment for Alternative Minimum Tax purposes.

3. Sell shares in the next calendar year, but within 12 months or less after you purchased them

Grant date	12/31/2019
Exercise date	12/31/2021
Exercise price	$20
Market price on 12/31/2020	$45
Sale date	06/15/2022
Sale price	$30
Number of shares	100
Bargain element	$2,500
Actual gain from sale	$1,000

Unlike example 2, the compensation is calculated as either the bargain element or the actual gain from the sale of the stock - whichever is lower. This is because the market price on the day of the sale is less than that on the day you exercised your option.

The bargain element, that is, the difference between the exercise price and the market price on the day you exercised the options and purchased the stock is $2,500.

4. Sell shares at least one year and a day after you purchase, but less than two years after the grant date

Grant date	08/01/2020
Exercise date	02/01/2021
Grant price	$20
Market price on 02/01/2021	$45
Sale date	06/15/2022
Sale price	$85
Commissions paid at sale	$10
Number of shares	100
Bargain element	$2,500
Net gain	$3,990

The bargain element is calculated as the difference between the exercise price and the market price on the day you exercised the options and purchased the stock.

$45 Market Price - $20 Exercise Price = $25
$25 x 100 shares = $2,500 Bargain Element

This amount should be included in the total wages shown in Box 1 of the 2022 Form W-2 from your employer because this is a disqualifying sale (meaning that your gain does not qualify for capital gains treatment for which the rates are lower than for ordinary income in 2022). If this amount is not included in Box 1 of Form W-2, you still must add it to the amount of compensation income that you report on your 2022 Form 1040, line 7.

You also must report the sale of the stock on your 2022 Schedule D, Part II as a long-term sale. It is long term because more than one year passed between the date you acquired the stock and the date you sold it.

For reporting purposes on Schedule D:

The date acquired is 02/01/2021.
The date sold is 6/15/2022.
The sales price is $8,490. This is the price at the date of sale ($85) times the number of shares sold (100), or $8,500. We then subtract the commissions paid on the sale (in this example $10), resulting in $8,490. This amount should be reported as the gross amount on the 2022 Form 1099-B that you'll receive from the broker that handled the sale.
The cost basis is $4,500. This is the actual price paid per share times the number of shares ($20 x 100 = $2,000) plus the compensation income reported on your 2022 Form 1040 ($2,500).
The resulting gain is $3,990 ($8,490 - $4,500 = $3,990).

Find out if this was the case by looking at Form 6251 (Alternative Minimum Tax) for the year that you purchased the shares.
In our example, the amount that should have been reported on your 2022 Form 6251 was the bargain element ($45 - $20 = $25) times the number of shares (100), which equals $2,500.
So what do you do this year? You will have to report another adjustment on your 2022 Form 6251. We explain how you calculate your AMT adjustment in the section called Reporting an Incentive Stock Option Adjustment for the Alternative Minimum Tax below.

5. Sell shares at least one year and a day after you purchase and at least two years after the grant date

Grant date	01/01/2019
Exercise date	02/01/2020
Grant price	$20
Market price on 02/01/2020	$45
Sale date	06/15/2022
Sale price	$85
Commissions paid at sale	$10
Number of shares	100

This sale is a qualifying sale, because:

more than two years passed between the grant date and the sale date, and
more than one year passed between the exercise date and the sales date.

Because this is a qualifying sale, the 2022 Form W-2 you receive from your employer will not report any compensation amount for this sale.

Report the sale on your 2022 Schedule D, Part II as a long-term sale. It is long-term because more than one year passed between the date you acquired the stock and the date you sold it.

For reporting purposes on Schedule D:

The date acquired is 02/01/2021.
The date sold is 06/15/2022.
The sale price is $8,490. This is the price at the date of sale ($85) times the number of shares sold (100), or $8,500. We then subtract any commissions paid on the sale (in this example $10), resulting in $8,490. This amount should be reported as the gross amount on the 2022 Form 1099-B that you'll receive from the broker that handled the sale.
The cost basis is $2,000. This is the actual price paid per share times the number of shares ($20 x 100 = $2,000).
The long-term gain is the difference of $6,490 ($8,490 - $2,000 = $6,490).

Because this sale and the exercise of the options didn't occur in the same year, you must make an adjustment for AMT. When you originally purchased the stock, you should have reported an income adjustment for AMT purposes in that year.

Find out if this was the case by looking at Form 6251 (Alternative Minimum Tax) for the year that you purchased the shares.
In our example, the amount that should have been reported on your 2022 Form 6251 was the bargain element ($45 - $20 = $25) times the number of shares (100), which equals $2,500.
So what do you do this year? We'll explain how you calculate your AMT adjustment in the section below.

Reporting an Incentive Stock Option adjustment for the Alternative Minimum Tax

If you buy and hold, you will report the bargain element as income for Alternative Minimum Tax purposes.

Report this amount on Form 6251: Alternative Minimum Tax for the year you exercise the ISOs.
When you sell the stock in a later year, you must report another adjustment on your Form 6251 for the year of sale.

But what is the adjustment you should report? The year-of-sale Form 6251 adjustment is added to the stock's cost basis for Alternative Minimum Tax purposes (but not for regular tax purposes).

So, in example 5, rather than using a cost basis of $2,000 for AMT, a cost basis of $4,500 ($2,000 plus $2,500 of the AMT adjustment from the year of exercise) should be used.
This results in a $3,990 gain for AMT purposes from the sale, which differs from the regular tax gain of $6,490 by exactly $2,500.

Unused AMT credits

In the year that you exercise an Incentive Stock Option, the difference between the market value of the stock on the exercise date and the exercise price counts as income under the AMT rules, which can trigger an AMT liability. However, you will also generally earn an AMT credit in that year.

You can use the credit to lower your tax bill in later years. However, there are limitations on when you can use an AMT credit. In some cases, AMT credits cannot be used for several years. Fortunately, a taxpayer-friendly change in 2008 allows individuals with unused AMT credits that are over three years old (so-called long-term unused AMT credits) to cash them in.

For the 2022 tax year, long-term unused AMT credits are those that were earned in pre-2007 years.
Taxpayers with long-term unused credits from pre-2007 years can generally collect at least half their credit amounts by filing their 2022 returns, and the remainder can be collected by filing their 2022 returns.
To figure the amount of unused AMT credits that can be collected under this rule, fill out Form 8801 (Credit for Prior Year Minimum Tax).

Consider the entire picture

It's important to take a look at the whole picture of your capital gains and losses for AMT purposes when you sell stock that you purchased by exercising Incentive Stock Options. If the market turns on you after you have exercised your options and the current value of your stock is now less than what you paid, you could still be subject to the Alternative Minimum Tax.

One way around that is to sell the stock in the same year that you bought it, creating a "disqualifying" disposition. That way you will not be subject to the AMT, but you would be subject to regular tax on the difference between your option exercise price and the sales price.

For example, assume you exercised options at $3 a share on a day when the stock was selling for $33, and the stock value later dropped to $25.

If you sell the stock at $25 before the end of the year, you would be taxed at ordinary income tax rates on $22 per share ($25-$3) and not be subject to any AMT concerns.
But if you hold onto the stock, you would be taxed for AMT purposes in the year you exercised the option on the phantom profit of $30 a share—the difference between your option exercise price and market price on the day you bought the shares—even if the actual market price of your shares fell after that date.
It may be advisable to consult with a tax professional prior to making any transactions that involve ISO shares.

TurboTax Premier Edition provides extra help with investments, so you can track and calculate your gains and losses—and TurboTax calculations are guaranteed accurate.

A word of caution

Your employer is not required to withhold income tax when you exercise an Incentive Stock Option since there is no tax due (under the regular tax system) until you sell the stock. Although no tax is withheld when you exercise an ISO, tax may be due later when you sell the stock, as illustrated by the examples in this article. Be sure to plan for the tax consequences when you consider the consequences of selling the stock.

For additional information, see IRS Publication 550: Investment Income and Expenses (Including Capital Gains and Losses) and Stock Options in IRS Publication 525: Taxable and Nontaxable Income.

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CompleteCheck: Covered under the TurboTax accurate calculations and maximum refund guarantees. Limitations apply. See Terms of Service for details.
1099-K Snap and Autofill: Available in mobile app and mobile web only.
1099-NEC Snap and Autofill: Available in TurboTax Premium (formerly Self-Employed) and TurboTax Live Assisted Premium (formerly Self-Employed). Available in mobile app only. Feature available within Schedule C tax form for TurboTax filers with 1099-NEC income.
Year-Round Tax Estimator: Available in TurboTax Premium (formerly Self-Employed) and TurboTax Live Assisted Premium (formerly Self-Employed). This product feature is only available after you finish and file in a self-employed TurboTax product.
**Invite a Friend: Rewards good for up to 10 friends, or $250 - see official terms and conditions for more details.
Average Refund Amount: Sum of $3252 is the average refund American taxpayers received based upon IRS data date ending 12/30/22 and may not reflect actual refund amount received.
Average Deduction Amount: Based on the average amount of deductions/expenses found by TurboTax Self Employed customers who filed expenses on Schedule C in Tax Year 2021 and may not reflect actual deductions found.
More self-employed deductions based on the median amount of expenses found by TurboTax Premium (formerly Self Employed) customers who synced accounts, imported and categorized transactions compared to manual entry. Individual results may vary.
TurboTax Online Business Products: For TurboTax Live Assisted Business and TurboTax Full Service Business, we currently don’t support the following tax situations: C-Corps (Form 1120-C), Trust/Estates (Form 1041), Multiple state filings, Tax Exempt Entities/Non-Profits , Entities electing to be treated as a C-Corp, Schedule C Sole proprietorship, Payroll, Sales tax, or Quarterly filings, and Foreign Income.

TURBOTAX CD/DOWNLOAD GUARANTEES

TurboTax Individual Returns:

100% Accurate Calculations Guarantee – Individual Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we’ll pay you the penalty and interest. Excludes payment plans. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Business returns. Additional terms and limitations apply. See License Agreement for details.
Maximum Refund Guarantee / Maximum Tax Savings Guarantee - or Your Money Back – Individual Returns: If you get a larger refund or smaller tax due from another tax preparation method by filing an amended return, we'll refund the applicable TurboTax federal and/or state software license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Business returns. Additional terms and limitations apply. See License Agreement for details.
Audit Support Guarantee – Individual Returns: If you receive an audit letter from the IRS or State Department of Revenue based on your 2022 TurboTax individual tax return, we will provide one-on-one question-and-answer support with a tax professional, if requested through our Audit Support Center, for audited individual returns filed with TurboTax for the current 2022 tax year and, for individual, non-business returns, for the past two tax years (2021, 2020). Audit support is informational only. We will not represent you before the IRS or state tax authority or provide legal advice. If we are not able to connect you to one of our tax professionals, we will refund the applicable TurboTax federal and/or state license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax. Excludes TurboTax Business returns. Additional limitations apply. See License Agreement for details.

TurboTax Business Returns:

100% Accurate Calculations Guarantee – Business Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we’ll pay you the penalty and interest. Excludes payment plans. You are responsible for paying any additional tax liability you may owe. Additional limitations apply. See License Agreement for details.
Maximum Tax Savings Guarantee: If you get a smaller tax due (or larger business tax refund) from another tax preparation method using the same data, TurboTax will refund the applicable TurboTax Business Desktop license purchase price you paid. See License Agreement for details.
Satisfaction Guarantee/ 60-Day Money Back Guarantee: If you're not completely satisfied with TurboTax Desktop, go to refundrequest.intuit.com within 60 days of purchase and follow the process listed to submit a refund request. You must return this product using your license code or order number and dated receipt.

TURBOTAX CD/DOWNLOAD

Installation Requirements: Download option requires a free online Intuit account. Product activation requires internet connectivity. You must accept the TurboTax License Agreement to use this product. Not for use by paid preparers.
TurboTax CD/Download Products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees may apply for e-filing state returns. E-file fees may not apply in certain states, check here for details. Savings and price comparison based on anticipated price increase. Software updates and optional online features require internet connectivity.
Fastest Refund Possible: Fastest federal tax refund with e-file and direct deposit; tax refund time frames will vary. The IRS issues more than 9 out of 10 refunds in less than 21 days.
Average Refund Amount: Sum of $3252 is the average refund American taxpayers received based upon IRS data date ending 12/30/22 and may not reflect actual refund amount received.
TurboTax Product Support: Customer service and product support hours and options vary by time of year.
#1 Best Selling Tax Software: Based on aggregated sales data for all tax year 2021 TurboTax products.
Deduct From Your Federal Refund: A $40 Refund Processing Service fee applies to this payment method. Prices are subject to change without notice.
Data Import: Imports financial data from participating companies; May require a free Intuit online account. Quicken and QuickBooks import not available with TurboTax installed on a Mac. Imports from Quicken (2020 and higher) and QuickBooks Desktop (2020 and higher); both Windows only. Quicken import not available for TurboTax Business. Quicken products provided by Quicken Inc., Quicken import subject to change.

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Incentive Stock Options (2024)

Let a tax expert do your investment taxes for you

What are Incentive Stock Options?

Why are Incentive Stock Options more favorable tax-wise?

How transactions affect your taxes

1. Exercise your option to purchase the shares and hold them

2. Exercise your option to purchase the shares, and then sell those shares within the same calendar year

3. Sell shares in the next calendar year, but within 12 months or less after you purchased them

4. Sell shares at least one year and a day after you purchase, but less than two years after the grant date

5. Sell shares at least one year and a day after you purchase and at least two years after the grant date

Reporting an Incentive Stock Option adjustment for the Alternative Minimum Tax

Unused AMT credits

Consider the entire picture

A word of caution

Let a tax expert do your investment taxes for you

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