Accurate records ensure that income from stock options is correctly reported for tax calculation. Non-statutory stock options are grants to employees to purchase shares of company stock. They are "non-statutory" because recipients do not obtain any special benefits under the income tax statutes. Income is taxable when the options are exercised. The difference between the option exercise price—the cost to buy the stock—and the value of the stock on the exercise date is an immediately taxable profit. That amount is added to the employee's W-2 and taxed as ordinary compensation. The employee has a capital gain when the stock is sold.
Examine Box 1 of your Form W-2. It should be a higher amount than your annual salary. The increase is your income from exercising the stock options. Your employer will provide details on the amount in Box 1 to ensure that it includes salary, plus the difference between the option exercise price and the value of stock purchased on the exercise date.
Enter on Line 7 of Form 1040 the amount from Box 1 of your W-2. Include W-2 income from other employers, including the W-2 of a spouse if you file a joint tax return. Add the income from exercising the stock options if that amount is not already on your W-2.
Record the option exercise date in the first column of the ledger.
Write the market value of the stock on the option exercise date in the next ledger column. Label the column "cost basis."
Keep the ledger as a record of your purchase date and cost basis. Use this to determine taxable gain or loss when the stock is sold.
If you sell the stock upon exercising the options, you do not have any capital gain. However, you have to report the sale on Schedule D (Capital Gains and Losses). On Schedule D, the exercise date is both the “Date acquired” and the “Date sold.” The “Sales price” is the sale proceeds you received and the “Cost or other basis” is the market value on the exercise date. A small loss is possible as a consequence of the any commission deducted from the sale proceeds.
Do not report as a capital gain the difference between option exercise price and the value of stock on the exercise date. This amount is already taxed on Line 7 of Form 1040 as ordinary compensation. Reporting that amount on Schedule D results in paying tax again on the same amount.
Things You'll Need
Form W-2 from employer
Form 1040 – Personal Income Tax Return
Option exercise date
Stock value on the date of exercise