Employees who have company stock options can often turn them into money, though if prices go down exercising an option could result in a loss. Many employees choose to buy and sell at the same time, resulting in two transactions that typically happen just minutes apart. Any gain or loss resulting from these transactions must be reported to the Internal Revenue Service on Form 1040. Schedule D is used to provide the details.
A stock option is when a person has the right to buy stock for a certain price. This option may have been purchased or it might have been given to an employee by his company as a recruiting tool or other type of incentive. An option includes not only the price the stock can be purchased for, but also an expiration date. If the option is not exercised by that date it is no longer valid.
A cashless sale occurs when an employee has a company stock option that she wants to exercise, but she wants to sell the stock immediately after purchasing it. To do so, she contacts a broker in order to buy the stock at the option price, and lets him know that she wishes to sell it again right away. In many cases the broker will advance the employee the money to purchase the stock at the option price. The stock is sold again right away, and the broker is able to recover the advance, but for the employee the transaction was cashless because none of her money was required.
A cashless transaction is usually done when the fair market value, FMV, of the company stock is reasonably high. The option price is often considerably less than the FMV, so the employee gets a substantial discount on the current price. Once the stock is sold at the FMV and the broker has deducted the purchase cost, the balance of the sales amount, less any brokerage fees, is given to the employee. Depending on the number of shares and the difference between the option price and the FMV, this may result in a significant amount of income for the employee.
The employee will see his profit from the transaction reported as ordinary income on his W-2 form. The amount he actually received will be included with wages and other compensation and shown as a single total in box 1 of the W-2, and the income realized from the sale of the stock will appear in box 12, next to the letter ”V.” This amount is used along with the purchase price on Schedule D, plus any costs, to determine net gain or loss. Since the purchase and sale occurred in a short time frame, section one of Schedule D is used. This figure is then transferred to the 1040.
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