NSO's or ISO's same day sale

Hello to all the tax pros who are finally relaxing after 7/15.

Client has a block of options in a private company that can be treated as ISO or NSO. She is an employee. She has a buyer already lined up for the shares and wants to sell a good portion of the block.

She must exercise some as NSO, some as ISO, can't be 100% of one type... The split can swing from 56% ISO / 44% NSO all the way to 87% NSO / 13% ISO.

As a high 6 figure wage earner AMT would be a factor if stock isn't sold during year but client intends to sell within weeks.

Client asked me to advise on best mix of NSO and ISO for least tax.

Am i missing something? Seems to me that if client intends to sell soon enough that ISO/AMT issue is not a factor, that there is no difference in the tax consequences. All the gain would be ordinary income. Gain would be Sale price - Stock price

Do I have this right? Thanks for your help.

Debbie

Yes. You are correct about the AMT issue. It looks like there may be savings on the Social Security & Medicare tax for the disqualifying dispositions of ISOs.

https://www.insidecompensation.com/2013 ... employees/

It is less clear how a disqualifying disposition of ISO shares is treated for purposes of the tax on net investment income. When an employee makes a disqualifying disposition of ISO shares, the employee recognizes ordinary income equal to the excess of the fair market value of the shares on the exercise date over the exercise price; any remaining appreciation from the date of exercise through the date of disposition is treated as capital gain. The amount treated as ordinary income is excluded from “wages” for FICA purposes, and a special exemption in the statutory option provisions relieves an employer from any obligation to withhold federal income tax on this amount. Even though a disqualifying disposition of ISO shares does not result in federal income tax withholding, however, the ordinary income that an employee recognizes upon a disqualifying disposition of ISO shares is compensation reportable on Form W-2 and deductible by the employer. Because the tax on net investment income generally does not apply to income received as compensation for services, ordinary income recognized on a disqualifying disposition of ISO shares probably is exempt from the 3.8% tax.

Thanks Wiles..if I read your response (and other research materials) correctly:

In both cases the income from the :"spread" is ordinary and reported on the w2... with FIT and SS and Medicare withheld on the NSO, but with no required withholding at all for the ISO.

The subsequent capital gains are reported on Schedule D for both types of options.

Additional medicare and NIIT is calculated for the NSO's, not for the ISO's.

The subsequent capital gains are reported on Schedule D for both types of options.

NSO dispositions will always be recognized on the W-2. Never lands on Schedule D

As for ISO dispositions, same day sale will land on the W-2, without the FICA/Medicare. A high 6 figure earner obviously will only be subject to Medicare tax.

There are many situations where ISO shares can have an ordinary component and a cap gain component, but not on same day sales. To obtain cap gain treatment of the ISO disposition, the sale has to be for a price higher than the FMV on exercise date.

Additional medicare and NIIT is calculated for the NSO's

As mentioned above, there will be Medicare tax on the NSO, but no NIIT as the gain will be on the W-2

What is the spread on the FMV vs. exercise price on the ISO shares? Same for NSO shares

Thanks Doug, the spread is about five dollars for each option flavor.

This has been my guidance to clients with NSO shares. Since the income from NSO's are considered compensation, and the gain will end up on the W-2, treat the NSO shares as any other stock you might own. When it has reached a given price, sell.

Too many times I have seen clients leave their current employer and have 90 days to settle up and the stock is down.

As to the ISO shares, there is the AMT aspect of the exercise as well as the DD rules. If AMT is not an issue to your client, I would exercise ISO shares first. No tax hit and your gain could have some LTCG benefits.

Doug... i'm confused... you say that NSO dispositions always reported on w2, and never on Sch D.... is that right?

Correct. And a caveat. Your post is asking about same day sales. My responses have been limited to this subject.

To elaborate, you can exericse NSO shares, and sell enough shares to cover the tax cost and the purchase price, and retain the remaining shares. The W-2 inclusion is added to the purchase price of the shares to obtain your costs basis.

The shares will be sold at a later date. At that point, you have an event that will end up on Schedule D.

So, a few items for which I still need clarification for the analysis for my client:

Income from the "spread" is reported on W2:
* NSO's subject to SS and Medicare taxes
* ISO's not subject to SS and Medicare taxes <==== IS THIS CORRECT?

As this is NOT a same-day sale, but a sale a few weeks after exercise
* NSO sale reported on Schedule D and subject to NIIT
* ISO sale reported on Schedule D and NOT subject to NIIT <==== IS THIS CORRECT?

Thanks,
Debbie

Sorry I deleted my post here. Could not find how to remove it.

Doug M said: "NSO dispositions will always be recognized on the W-2. Never lands on Schedule D."

This is NOT correct. The ordinary-income component of the stock's cost basis gets reported on W-2. Even if the stock is sold immediately, their proceeds will be lower than their FMV due to the sales commissions charged. When reported, as required, on Schedule D, the proceeds minus the cost basis will show a small amount of short-term capital loss, equal to the broker commissions amount.

Maria U. Ku, CPA
Oakland, CA

I believe Doug clarified his position on later date sale requiring reporting on Sch D in Post #8

As this is NOT a same-day sale, but a sale a few weeks after exercise
* NSO sale reported on Schedule D and subject to NIIT
* ISO sale reported on Schedule D and NOT subject to NIIT <==== IS THIS CORRECT?

NSO sale: the amount recognized as compensation income upon exercise is not subject to NIIT, but is subject to the 0.9% Medicare tax. Once the NSO is exercised and the stocks are transferred to the employee, however, subsequent dividends and gain on disposition of the shares are subject to NIIT.

ISO sale: The capital gain on the sale of shares received as a result of exercising ISOs is included in net investment income and is subject to NIIT. In the case of a disqualifying disposition of ISO shares, the ordinary income recognized by the employee is compensation and is, therefore, not subject to NIIT but is (EDIT) NOT subject to the 0.9% Medicare tax.

Hi, it seems that Taxmaster and Wiles have different thoughts on whether the ISO disqualifying disposition is subject to the FICA/Medicare tax as well as the additional 0.9%. I've seen a second reference that says that the ordinary income component of the ISO disqsualifying disposition is NOT subject to FICA/Medicare tax.

Any other thoughts?

Debbie

I've seen a second reference that says that the ordinary income component of the ISO disqsualifying disposition is NOT subject to FICA/Medicare tax.

Sorry, did not mean to say ISO disqualifying disposition was subject to excess FICA. ISO disqualifying disposition is not usbject to FICA or FIT or FUTA. IRC 421(b),423(c),321(a)(22), and 3306(b)(19). Since Medicare surtax 0.9% is on FICA wages, ISO's also exempt from the medicare surtax.

mariaku said:

Doug M said: "NSO dispositions will always be recognized on the W-2. Never lands on Schedule D."

This is NOT correct.

I stand behind my statement that NSO dispositions end up on the W-2. I do not see a reason to explain the $35 transaction fee will net a cap loss on the schedule D. This post is about gains.

Agree with TAXMASTER on the FICA/Medicare taxes on ISO transactions.