I recently sold my vested incentive stock-options back to my employer (i.e. so rather than having to spend $20,000 of my own money to exercise my options and make very little paper gain initially, I opted for a larger cash gain more immediately (e.g. $10,000) instead). I received the money in my bank account a few days ago.

How is this money taxed? There hasn't been any withholding from the money I received - and it isn't money received in exchange for me doing any work (i.e. not W-2 or 1099-MISC). While it's money received from the sale of an asset, I'm confused as to what the cost-basis would be (the options vested accrue weekly during my employment). Is there special handling for this?

  • That is not the way options work. Any broker would have exercised your options without an outlay of capital Basically you receive the difference in the stirke and current price minus the commission Given your lack of understanding on this subject, and strangeness of this deal, I would suggest seeing a tax professional.
    – Pete B.
    Aug 30 '18 at 10:56
  • @PeteB. Since ordinarily the spread is taxed as a (long-term) capital gain if you hold ISO shares for a year, rather than ordinary income, there could be a very good reason to prefer this kind of immediate buyout to a cashless exercise.
    – chepner
    Aug 30 '18 at 15:52
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    Ask your company how this is treated; since (AFAIK) ISOs aren't transferable, this may not technically constitute a sale, but rather your company giving you some alternate compensation in lieu of ISOs.
    – chepner
    Aug 30 '18 at 15:53

You sold an asset you own whose cost to you was zero, and whose value was not "readily determinable" at grant time. So your cost basis is zero and you pay capital gains tax on the full sale price. You don't mention the date(s) of the ISO grants. I would think you would determine long term vs. short term by the grant date(s) vs. the sell date.

"Seek professional advice" is good advice in this situation, because there are questions about whether this is an arm's length transaction that bear upon how it is taxed. Also see IRS Pub 525: https://www.irs.gov/pub/irs-pdf/p525.pdf , p. 11 ff.

  • The options were granted on the first day of my employment (over a year ago, thus long-term) but they vested on a weekly basis so some of them vested less than a year ago (so short-term).
    – Dai
    Aug 30 '18 at 21:49
  • @Dai I assume you are selling shares back to your employer, not the stock options themselves. In that case what matters is when you obtained the shares, i.e. when you exercised the options.
    – Craig W
    Aug 31 '18 at 21:39
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    His question says he sold the options back to his employer.
    – smr888
    Aug 31 '18 at 22:39
  • @smr888 I know but I'm not convinced that is correct as I don't believe you can sell ISOs. People often use the terms options and shares interchangeably.
    – Craig W
    Sep 1 '18 at 11:28

My employer's finance person got back to me today and told me that they're treating the exchange as a business expense so they'll issue me 1099-MISC statement with the funds marked as "Other income", so I'll have to pay at least federal income tax on the money (but not self-employment tax, for example).

  • Careful - are you sure there's no chance that capital gains treatment is available for you? What's simplest for your employer is not necessarily what is right, or what is best for you. Sep 5 '18 at 15:06

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