How Stock Options Are Taxed & Reported.
Stock options are an employee benefit that enables an employee to buy the employer’s stock at a discount to the stock’s market price. The options do not convey an ownership interest, but exercising them to acquire the stock does. There are different types of options, each with their own tax results.
Two types of stock options.
Stock options fall into two categories:
Statutory stock options, which are granted under an employee stock purchase plan or an incentive stock option (ISO) plan.
Nonstatutory, or non-qualified, stock options, which are granted without any type of plan.
Tax rules for statutory stock options.
The grant of an ISO or other statutory stock option does not produce any immediate income subject to regular income taxes. Similarly, the exercise of the option to obtain the stock does not produce any immediate income as long as you hold the stock in the year you acquire it. Income results when you later sell the stock acquired by exercising the option.
However, exercising an ISO produces an adjustment for purposes of the alternative minimum tax, or AMT (a shadow tax system designed to ensure that those who reduce their regular tax through deductions and other tax breaks will pay at least some tax). The adjustment is the difference between the fair market value of the stock acquired through the exercise of the ISO over the amount paid for the stock, plus the amount paid for the ISO, if any. However, the adjustment is required only if your rights in the stock are transferable and not subject to a substantial risk of forfeiture in the year that the ISO is exercised. And the fair market value of the stock for purposes of the adjustment is determined without regard to any lapse restriction when rights in the stock first become transferable or when the rights are no longer subject to a substantial risk of forfeiture.
If you sell the stock in the same year that you exercised the ISO, no AMT adjustment is required. This is because the tax treatment becomes the same for regular tax and AMT purposes.
If you have to make an AMT adjustment, increase the basis in the stock by the AMT adjustment. Doing this ensures that when the stock is sold in the future, the gain taxable for AMT purposes is limited (i. e., you don’t pay tax twice on the same amount).
How reporting works.
When you exercise an ISO, your employer issues Form 3921, Exercise of an Incentive Stock Option Plan under Section 423(c), which provides the information needed for tax-reporting purposes. Here’s an example of how to use the information from Form 3921 to report the exercise of an ISO:
Example: This year you exercised an ISO to acquire 100 shares of stock, the rights in which became immediately transferable and not subject to a substantial risk of forfeiture. You paid $10 per share (the exercise price), which is reported in box 3 of Form 3921. On the date of exercise the fair market value of the stock was $25 per share, which is reported in box 4 of the form. The number of shares acquired is listed in box 5. The AMT adjustment is $1,500 ($2,500 [box 4 times box 5] minus $1,000 [box 3 times box 5]).
When you sell the stock acquired through the exercise of an ISO or an employee stock purchase plan, you report gain or loss on the sale. When the stock was acquired at a discount under an employee stock option plan, you’ll receive Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan, from your employer or the corporation’s transfer agent . The information on this form helps you determine the amount of gain or loss, and whether it is capital or ordinary income.
Tax rules for nonstatutory stock options.
For this type of stock option, there are three events, each with their own tax results: the grant of the option, the exercise of the option and the sale of stock acquired through the exercise of the option. The receipt of these options is immediately taxable only if their fair market value can be readily determined (e. g., the option is actively traded on an exchange). In most cases, however, there is no readily ascertainable value so the granting of the options does not result in any tax.
When you exercise the option, you include in income the fair market value of the stock at the time you acquire it (exercise the option), less any amount you pay for the stock. This is ordinary wage income reported on Form W-2; it increases your tax basis in the stock.
Later when you sell the stock acquired through exercise of the options, you report capital gain or loss for the difference between your tax basis and what you receive on the sale.
The Bottom Line.
Stock options can be a valuable employee benefit. However, the tax rules are complex. If you receive stock options, talk with your tax advisor to determine how these tax rules affect you.

M-1 adjustment for stock options

26% , on Alternative Minimum Taxable Income (AMTI) up to.
2017 - $187,800 ($93,900 for married filing separately)
2016 - $186,300 ($93,150 for married filing separately)
2015 - $185,400 ($92,700 for married filing separately)
28% on AMTI over the above amounts.
AMT Exemption Amounts.
(Before Phase - Out)
Taxpayers Filing Single or Head of Household:
Married Filing Jointly or Qualifying Widower:
Married Filing Separately:
Phase - Out Thresholds.
The AMT exemption is reduced by 25% of the amount that alternative minimum taxable income exceeds the threshold amounts listed below.
Single or Head of Household.
Married Filing Jointly or Qualifying Widowers.
Married Filing Separately.
Per Code Sec. 56, in calculating alternative minimum taxable income (AMTI), a taxpayer must add or subtract amounts from regular taxable income due to the different treatment of certain tax items for AMT. These additions and subtractions are called AMT adjustments.
NOTE: Individual taxpayers in some cases must also increase regular taxable income in some cases due to the different treatment of certain other tax items for AMT purposes under Code Sec. 57. These increases, called AMT preferences, are discussed on the AMT Preferences page.
Some of the adjustment items are very common, while others only affect a small number of individual taxpayers. The items that are subject to adjustment for AMT for individual taxpayers include:
An individual taxpayer’s AMT adjustment items are added or subtracted in the calculation of AMTI on page 1 of Form 6251. These adjustments are discussed below.
NOTE: All line references below are to the 2017 Form 6251.
Limitation on Overall Itemized Deductions.
The overall limitation on itemized deductions, reinstated in 2013, is an.
adjustment for AMT on Form 6251, line 6.
Miscellaneous Itemized Deductions.
For AMT, an individual taxpayer cannot deduct miscellaneous itemized deductions subject to the 2% of AGI floor (as defined in Code Sec. 67(b)). Therefore, an individual taxpayer must add back these deductions in calculating AMTI. The miscellaneous itemized deductions subject to the 2% of AGI floor include (but are not limited to):
Unreimbursed employee business expenses. Tax return preparation fees. Expenses paid to collect or produce taxable income or to manage or protect property held to earn taxable income.
An individual taxpayer reports the AMT adjustment amount for these items.
(the amount from line 27 of Schedule A, Form 1040) on Form 6251, line 5.
State, Local, and Foreign Taxes.
No deduction is allowed in calculating AMTI for the taxes listed in Code Secs. 164(a) and 164(b)(5)(A). Therefore, an individual taxpayer must add back deductions for these taxes in calculating AMTI. These taxes include:
State, local, and foreign income, war profits, and excise taxes. State, local, and foreign real property taxes. State and local personal property taxes. State, local, and foreign taxes paid or accrued in carrying on a trade or business or an activity for the production of income. State and local sales taxes deducted in lieu of income taxes.
An individual taxpayer reports the AMT adjustment amount for these items.
(line 9 of Schedule A, Form 1040) on Form 6251, line 3.
Standard Deduction and Personal Exemptions.
The basic and additional standard deduction and the deduction for personal.
exemptions are not allowed for AMT. Because the calculation of AMTI starts.
with adjusted gross income (AGI) for individual taxpayers taking the standard deduction (AGI less itemized deductions for taxpayers who itemize), no entry is necessary on Form 6251 to take into account the adjustments for the standard deduction and the personal exemption.
NOTE: The disaster loss deduction under Code Sec. 63(c)(1)(D) and the motor vehicle sales tax deduction under Code Sec. 63(c)(1)(E), which are part of the overall standard deduction, are allowed for AMT.
Medical and dental expenses were deductible in calculating AMTI to the extent that they exceed 10% of AGI. For years before 2013, they are deductible for regular tax purposes to the extent that they exceed 7.5% of AGI and the difference between the deductions for AMT and regular tax (which for practical purposes is the lesser of the amount on line 4 of Schedule A, Form 1040, and 2.5% of the amount on line 38, Form 1040) must be added in calculating AMTI on Form 6251, line 2.
For 2013 and later years, the deduction will be the same for regular tax and AMT, so no adjustment will generally be necessary. However, in 2013 through 2016, a transitional rule in Code Section 213(f) allows taxpayers 65 years and older to continue deducting medical and dental expenses in excess of 7.5% of AGI for regular tax purposes. However, this rule will not apply in determining the AMT deduction. Therefore, taxpayers affected by Code Section 213(f) will have an AMT adjustment for medical and dental expenses in those years.
Mortgage interest: The rules for deducting mortgage interest are more restrictive for AMT than for regular tax. If a taxpayer can deduct more mortgage interest for regular tax than for AMT, the difference is an adjustment that the taxpayer adds back in calculating AMTI.
For the regular tax, individual taxpayers can deduct interest on a mortgage loan that the taxpayer used to purchase a qualified residence (i. e., the taxpayer’s principal residence and one other residence selected by the taxpayer that the taxpayer uses as a personal residence) or refinance an existing loan that was used to purchase a qualified residence, to the extent the refinancing loan does not exceed the original mortgage loan. The taxpayer may also deduct interest on a home equity loan or line of credit. For the AMT, an individual may only deduct interest on a mortgage loan used in acquiring, constructing, or substantially improving a principal residence or qualified dwelling.
NOTE: Because of the “acquiring, constructing, or substantially improving” rule, and the lack of an AMT provision for deducting home equity interest, interest on a home equity loan or line of credit will not be deductible for AMT if a taxpayer uses the proceeds from the loan or line of credit for purposes unrelated to the home.
For the regular tax, a qualified residence (in the case of the taxpayer’s principal residence and an elected second residence) includes a house, mobile home, condominium, houseboat, house trailer, and stock held by a tenant - stockholder in a cooperative housing corporation. For AMT, this is also the case for the taxpayer’s principal residence. However, for AMT purposes, the second residence can only be a home, apartment, condominium, or a mobile home not used on a transient basis.
An individual taxpayer adds back the amount of the adjustment for mortgage interest in calculating AMTI on Form 6251, line 4.
EXAMPLE: T owns a home and a boat that qualifies as a residence for purposes of the regular tax mortgage interest deduction. T has an original mortgage loan used to purchase the home, a home equity line of credit on the home that he has used solely to pay for several vacations, and a loan secured by the boat that he used to purchase the boat. For regular tax purposes, T will be able to deduct the interest on all three of these loans. For AMT purposes, he will only be able to deduct the interest on the original home mortgage loan. T must add back the interest on the home equity line of credit and the boat loan in calculating his AMTI.
Investment interest: For regular tax purposes, an individual taxpayer can deduct investment interest to the extent of his or her net investment income. A taxpayer also can deduct investment interest to the extent of net investment income for AMT purposes, but the taxpayer must take AMT adjustment and preference items and the AMT loss disallowances under Code Sec. 58 into account in determining the amount of investment interest expense that is deductible in computing AMTI. Investment interest that a taxpayer cannot deduct in the current year due to the net investment income limitation can be carried forward and deducted (subject to the limitation) in the next tax year. The difference between the regular tax deduction for investment interest and the AMT deduction for investment interest is an AMT adjustment that is included on Form 6251, Line 8.
Interest on a mortgage loan that is deductible under the AMT rules for home mortgage interest described above is not investment interest. However, where the taxpayer uses the proceeds of a mortgage loan to purchase investment property, the interest on the loan is deductible investment interest for AMT purposes if it is not deductible under the home mortgage interest rules.
Interest on borrowed funds used to purchase private activity bonds are investment interest for AMT because the interest from private activity bonds is included in AMTI. Likewise, the interest on private activity bonds is included in investment income.
Incentive Stock Options.
For regular tax, under Code Section 421, a taxpayer that exercises an incentive stock option is not required to include the difference between the option price and the fair market value of the underlying stock at the time of exercise in income in the year of exercise. For AMT, this difference must be included in income in the year of exercise. Thus, the amount of the difference is an AMT adjustment added back in calculating AMTI on Form 6251, line 14.
NOTE: This adjustment does not apply if the taxpayer sells the stock received in the ISO exercise in the same tax year he or she exercises the ISO.
EXAMPLE: R exercises 100 ISOs in 2017 when the FMV of the stock underlying the options is $10 per share. R pays $5 per share when she exercises the ISOs. R does not recognize any income for regular tax in 2017 due to the exercise of the ISOs. In calculating AMTI, R must add back $500, the difference between the amount when she exercised the ISOs and the FMV of the stock she receives.
For AMT purposes, a taxpayer adds the amount of the adjustment to the basis of the stock.
EXAMPLE: The facts are the same as in the preceding example. R has a regular tax basis of $500 in the stock she receives when she exercises the ISOs, the price she paid to exercise the options. Her AMT basis in the stock is $1000, the price she paid to exercise the options plus the amount of her AMT adjustment.
The difference in basis caused by the ISO adjustment will usually cause an AMT adjustment on the disposition of the stock in the year the stock is sold. The AMT adjustment for the disposition of property is discussed below.
In general, unless a taxpayer elects to use the same method of calculating depreciation for regular tax and AMT on post - 1986 assets, depreciation is calculated differently for regular tax and for AMT on those assets. In most cases, the differences in the depreciation rules for the two systems results in a greater depreciation deduction for a particular asset for regular tax in the earlier years of the asset’s recovery period and a lower deduction for regular tax in the later years. The difference between the aggregate amount of depreciation deductions for regular tax and for AMT is an adjustment that is added back or subtracted in the calculation of AMTI on Form 6251, line 18.
NOTE: See the instructions for Form 6251, under the heading “Post - 1986 Depreciation” for more information on the specific differences in the calculation of regular tax and AMT depreciation.
For a taxpayer that owns an interest in a partnership or shares in an S corporation, the K - 1 the taxpayer receives from the partnership or S corporation frequently includes a passthrough of an AMT depreciation adjustment amount. On a partnership K - 1, the adjustment is reported on line 17 (Code A). On an S corporation K - 1, the adjustment is reported on line 15 (Code A).
Disposition of Property.
The gain or loss recognized on the disposition of property may be different for regular tax and AMT because the property the taxpayer disposes of has a different basis for regular tax and AMT. This can occur for a number of reasons, including differences in depreciation deductions taken under the two systems for the property and in the case of stock received through the exercise of an ISO, the difference in basis caused by the ISO AMT adjustment discussed above. Because basis may be higher or lower for regular tax than it is for AMT, this adjustment may be positive or negative. The taxpayer includes the adjustment in calculating AMTI on Form 6251, line 17.
NOTE: It is important to remember that the $3,000 limitation on the deduction of capital losses that applies to individual taxpayers for regular tax also applies for AMT.
Alternative Tax Net Operating Losses, Amortization Expenses of Pollution Control Facilities, Circulation Costs, Long - Term Contract Expenses, Mining Costs, Research and Experimental Costs.
Except for adjustments passed through from partnerships, LLCs, and S corporations, these are all comparatively rare adjustments for individuals. More detail on these adjustments can be found in the instructions for Form 6251.
NOTE: If you own a sole proprietorship business and report any of these types of expenses on Schedule C, you should generally consult with a qualified tax professional when determining the amount of the AMT adjustment.

Understanding Adjusted Options.
Key Points.
Options may be adjusted if the underlying stock undergoes some type of reorganization.
Read about how to identify adjusted options.
Find out how you might deal with adjusted options.
Understanding how options are adjusted when the underlying stock goes through some type of reorganization has never been easy, and the fact that the rules have changed several times over the years doesn't help.
The last change took place following the OCC's (formerly the Options Clearing Corporation) options symbology conversion in May 2010, yet this topic remains relevant for many options traders.
There are certain characteristics common to all option contracts:
When the underlying company goes through some type of corporate reorganization, any of the last five items can change, resulting in an adjusted option. You have no control over whether these items will change, but an understanding of how and why they change can help you deal with them afterward.
The expiration date is a special case. It usually remains constant, but OCC can accelerate it when the underlying company undergoes a merger and the deliverable (the underlying shares) is converted into a 100% cash deliverable.
The causes for adjustments to options contracts are numerous. Below is a partial list that shows not only what causes the adjustment, but also what type of adjustment may occur. For example, when an ordinary cash dividend is paid, it typically has no effect on the option, whereas stock splits usually do.
Causes of adjusted options.
Ordinary cash dividend 1.
Extraordinary cash dividend 2.
Reverse stock split.
Merger or acquisition.
Stock symbol or.
company name change.
1. Paid on a quarterly or other regular basis, regardless of amount.
2. Not paid on a quarterly or other regular basis.
Source: Schwab Center for Financial Research.
Following the 2010 option symbology conversion, when an option symbol change is required, an adjusted option will typically have the same symbol as the standard option, but a numeric digit (1, 2 etc.) will be added as a suffix to identify it as an adjusted option. The numeric digit doesn't describe the adjustment, it only indicates that some sort of adjustment has occurred.
Identifying adjusted options.
There are several ways to help identify an adjusted option, starting with the way we just mentioned:
1. The underlying symbol within the option symbol is appended with a number (for example, XYZ1 10/20/2012 33.0 C).
2. The expiration header indicates that the options are adjusted.
3. The option seems much too cheap or too expensive.
Here's how an adjusted option may look in StreetSmart Edge® (the factors above are numbered in the screenshots):
Signs of an adjusted option.
Source: StreetSmart Edge®
There's another area within the option chains of StreetSmart Edge that will give you many of the details of how the option is structured after the adjustment. You can locate this screen by highlighting an option in the option chain, and clicking on the arrow at the beginning of the row. Look at the example below to see the contract specifications for XYZ1 October 20th, 2013 33.00 calls.
For this particular option, you can see that the reason it's trading at a price that's quite a bit higher than the standard 33.00 call is because it includes the delivery of 33 shares of ZYX and cash-in-lieu of $10.00 in addition to the 100 shares of XYZ. Looking at the expanded view, you may also find adjusted options where the contract size is greater than 100, options that include two or more different stocks, and options with a multiplier that's something other than 100. As noted above, all of these can occur when options are adjusted.
Contract specifications.
Source: StreetSmart Edge®
Dealing with adjusted options.
Adjusted options rarely represent a good trading opportunity. Always keep in mind the old adage: If it seems too good to be true, it probably is.
Don't panic if you already own an option position that goes through an adjustment—you won’t necessarily lose or gain any value as a result of the adjustment and, if your position is covered, your shares will also have been adjusted so that you remain covered. However, it's generally wise to avoid establishing new positions in options after they're adjusted.
Adjusted options often have the following characteristics:
Time values may be lower. Spreads may be wider. Volumes are usually lower. Open interest is usually lower. Bids may drop below intrinsic value near expiration.
When an option is adjusted (as in the example above) such that the number of shares deliverable (contract size) is something other than 100 shares of stock and/or it includes cash-in-lieu, it's sometimes very difficult to determine how much the option is in the money or out of the money.
Here's a formula for determining this value, which should help you make sense of the quoted option price for our example, XYZ1 10/20/2012 33.00 C:
ITM/OOTM amount = 994.45 ÷ 100.
ITM/OOTM amount = 9.94 (in the money, since the result is positive)
Knowing that this option is 9.94 in the money helps explain why the bid is 7.70 and the asking price is 12.30. This is especially true when you compare it to the standard 33.00 calls, which are out-of-the-money with an asking price of .03 since there are only 3 days until expiration.
Next Steps.
Schwab clients: Contact a Trading Specialist at 800-435-9050 for questions or log in to the Trading Services Learning Center. Not yet a client? Learn more about Schwab Trading Services.
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Schedule M-3 Adjustments: Tax vs. Book Income.
Preparing Schedules M-3 and M-1 to reconcile book to tax income can be an impossible task if the preparer is not aware of the differences between tax and book income. This practical seminar on Schedules M-3 and M-1 adjustments, designed for tax accountants and auditors:
Reviews the deduction relating to US production activities Explores in detail the major tax/book differences reported on Schedules M-3 and M-1 of business tax returns and why such differences exist Shows you how to reconcile book income with taxable income Equips you to correctly prepare corporate and partnership returns Provides the know-how to analyze frequently encountered adjustments.
To provide tax accountants and auditors with a sound knowledge of the differences between tax and book accounting that might be present in any business tax return. Auditors will be able to determine which items are relevant in preparing or reviewing the tax provision for financial purposes.
Different institutional objectives governing financial vs. tax reporting The differing definition of trade or business expenses for financial statement purposes vs. tax purposes Different accounting and tax standards as they relate to:
– Timing and deduction of expenses.
– Timing of inclusion of income.
– Accounting for business acquisitions.
– Capital gains and losses.
– Permissible tax accounting methods.
– Treatment of foreign income Computing Schedule M-3 or M-1 for:
– Partnerships and limited liability companies.