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Stocks Vs. Options

Arin V., EA , MBA
Arin is an Enrolled Agent (EA), authorized to represent taxpayers in front of the IRS, and holds a BA and MBA (Management) degree from California State University, Northridge.
When one thinks about investing, stocks are usually what come to mind. Indeed, investing in stocks has been such a big part of our society for so long. Now, with the advent of robo-advisors such as Wealthfront and Betterment, not to mention free stock trading through apps like Robinhood, stock investing has become mainstream not just among people in the middle of their careers, but also those who have just started their careers.

With that being said, it is important to distinguish between stocks, and their lesser-known cousins, options, because these two terms get bandied about quite often. Simply put, stocks are shares of ownership in individual companies, such as Amazon, or Google. An option, on the other hand, is akin to a contract which allows you to purchase the right to buy or sell shares of a stock for a set price at a future date. However, in this scenario, you do not own part of the company (as you would if you held outright the company’s stock). Also, in this scenario, you have a limited amount of time to exercise those options before they expire. 

Additionally, there are typically two types of options: statutory stock options, which are options granted under an employee stock purchase plan (ESPP) or incentive stock option plan (ISO), and non-statutory stock options, which are not granted under an ESPP or ISO.  Statutory stock options can be considered employee benefits that allow you to purchase the company’s stock at a discount on the market price.  

When it comes to the taxation of stocks, we must first look at the holding period. If you hold a stock for one year or less, and then you sell it, you will have a short-term capital gain or loss. On the other hand, if you hold a stock for more than one year, and then you sell it, you will have a long-term capital gain or loss. It is important to note that the long-term capital gains tax rate is lower than the short-term capital gains tax rate. Specifically, for tax year 2021, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your filing status and income. On the other hand, the short-term capital gains tax rate is equal to your ordinary income tax rate. This, of course, depends on your filing status and income as well. The short-term capital gains tax rate is much higher than the long-term rate, and can go from 10% to 37%, depending on your tax bracket.

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In regard to the taxation of options, you do not generally have to include any amount that you receive or exercise in your gross income for the year. However, depending upon when you exercise the stock options, you may be subject to the Alternative Minimum Tax (AMT), which can complicate things from a tax perspective. Also, the spread, which is the difference between the exercise price and the market price, is also known as the “bargain element”, and is taxed at ordinary income tax rates because the IRS considers this as part of employee compensation. Further, when you sell the stock that you bought when you exercised the option, this amount is treated either as a capital gain or a capital loss. Further, the holding period, described above, also applies. Therefore, when you sell a stock after exercising the option, the treatment is similar to the sale of an individual stock purchased and then sold. Additionally, in this scenario, there are two taxable events – the ordinary income tax on the bargain element, and then the capital gains tax on the sale of the stock. 

Given that the topic of stocks and options is so huge and often fraught with tax implications, if you are considering selling stocks or exercising and selling options, and need to understand the implications of doing so, especially when considering cross-border consequences, please get in touch with us today for an analysis of what your options are.

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