How do taxes work on ISOs?
Using ISOs, employees can acquire shares of company stock at a discounted rate and potentially receive tax breaks on the profits generated by the sale of that stock. Once sold, qualified ISOs are taxed at the current capital gains rate (zero to 20%, depending on income level) versus the ordinary income rate.
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.
With NSOs, you pay ordinary income taxes when you exercise the options, and capital gains taxes when you sell the shares. With ISOs, you only pay taxes when you sell the shares, either ordinary income or capital gains, depending on how long you held the shares first.
With incentive stock options (ISOs), the value of the exercise income appears on Form W-2 only if you made what is technically called a disqualifying disposition. That means you sold or gifted the stock before you met the required holding periods of one year from exercise and two years from grant.
They can only report the unadjusted basis — what the employee actually paid. To avoid double taxation, the employee must use Form 8949. The information needed to make this adjustment will probably be in supplemental materials that come with your 1099-B.
The main difference between NSOs and ISOs comes down to how they are taxed. If you recall, ISOs are only taxed at the capital gains tax when they are sold. NSOs can potentially be taxed on two occasions. To start, NSOs are taxed when the stock options are initially exercised.
The $100K Limit means that the maximum amount of ISOs that an employee can receive (vest) per year is $100K. The amount is computed by taking the per share FMV at the time of the grant and multiplying by the number of shares granted.
Employers do not obtain a tax deduction for an ISO unless there is a disqualifying disposition by the employee (see TX 17.4. 1). Therefore, a deferred tax asset is not recognized when an entity recognizes compensation cost for book purposes for such options.
ISOs aren't taxed when granted, upon vesting or when exercised. Taxes are deferred until shares are sold, and if you meet certain holding requirements, ISOs are subject only to capital gains taxes.
For your vested but unexercised ISOs, you'll typically have 90 days from your last day of employment to exercise your ISOs. After that, your ISOs will convert to nonqualified stock options (NSOs).