How to Report Non-Statutory Stock Options.
Accurate records ensure that income from stock options is correctly reported for tax calculation. Non-statutory stock options are grants to employees to purchase shares of company stock. They are "non-statutory" because recipients do not obtain any special benefits under the income tax statutes. Income is taxable when the options are exercised. The difference between the option exercise price—the cost to buy the stock—and the value of the stock on the exercise date is an immediately taxable profit. That amount is added to the employee's W-2 and taxed as ordinary compensation. The employee has a capital gain when the stock is sold.
Reporting Steps.
Examine Box 1 of your Form W-2. It should be a higher amount than your annual salary. The increase is your income from exercising the stock options. Your employer will provide details on the amount in Box 1 to ensure that it includes salary, plus the difference between the option exercise price and the value of stock purchased on the exercise date.
Enter on Line 7 of Form 1040 the amount from Box 1 of your W-2. Include W-2 income from other employers, including the W-2 of a spouse if you file a joint tax return. Add the income from exercising the stock options if that amount is not already on your W-2.
Record the option exercise date in the first column of the ledger.
Write the market value of the stock on the option exercise date in the next ledger column. Label the column "cost basis."
Keep the ledger as a record of your purchase date and cost basis. Use this to determine taxable gain or loss when the stock is sold.

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.

Nonqualified Stock Options.
Tax Consequences of Nonqualified (Nonstatutory) Stock Options.
Internal Revenue Code Section 83 governs nonstatutory stock options. Nonstatutory stock options trigger ordinary income to you at some point in time and produce a compensation deduction to the employer. §83 contains two rules affecting all nonstatutory stock option transactions. In the following circumstances, all stock options are considered not actively traded on an established market. Taxation at Grant (1) §83 will apply to the grant of a nonstatutory stock option only if the option has a readily ascertainable fair market value at the time of its grant. Nonstatutory stock options must meet four conditions to have a readily ascertainable fair market value. The option is transferable by the optionee. The option is exercisable immediately in full by the optionee. Neither the option, nor the underlying property is subject to any restrictions that have a significant effect on the option's value. The fair market value of the �option privilege� is readily ascertainable. Thus, valuation of the option privilege requires a prediction of the future course of the underlying property's value, something that is often impossible to do with reasonable accuracy. This one requirement alone effectively denies readily ascertainable fair market value status at grant to most options. Treatment: Assuming the above four conditions are met, the fair market value less any amount paid for the option will be taxed in the taxable year of the grant and treated as compensation income (ordinary income). There is no tax consequence upon the exercise of the option. Upon sale of the stock, you will realize capital gain. The amount of the gain will be the selling price reduced by the basis in the stock. Basis will equal the sum of the per share amount paid for the exercise of the option and any amount included in income upon the options grant. Taxation at Exercise (2) §83 will apply to the transfer of property pursuant to the exercise of a nonstatutory stock option only if the option did not have a readily ascertainable fair market value at its grant. Treatment: There is no taxable event at date of the grant. If the underlying property is not restricted when you exercise the options, compensation income is computed as the difference between the fair market value at date of exercise and date of the grant. The effect of not having a taxable event at the time of grant is to treat as compensation income, and not capital gain, the appreciation in the value of the property underlying the option between option grant and exercise. When you sell the stock, the basis in the stock will equal the sum of the exercise price plus the amount included in ordinary income at exercise. If the underlying property is restricted at exercise, you postpone the taxable event with respect to the options exercise until the restrictions lapse. However, you can make a §83(b) election within 30 days after the transfer of the property. This essentially closes the taxable event at exercise and provides an opportunity to limit ordinary income from the transaction to any difference on the date the property is transferred between the fair market value and the amount paid for the property. Any appreciation in the property after the date of transfer is converted into capital gain income. The employer will receive a deduction in the year in which the employee's income inclusion ends. For example, the deduction is allowed either (1) in the employer's year that ends with the employee's year (i. e., the employer and the employee use the same taxable year); or (2) in the employer's year in which the employee's year ends (i. e., if the employee and the employer use different taxable years). Generally, the employer's deduction is the same amount included in.
ordinary income by the employee; however, the employer's deduction can be limited in certain instances.
Under both rules above, the holding period for property acquired in a §83 transaction begins with the date on which the property becomes taxable as compensation income. The following maximum marginal tax rates are currently in effect:
The income arising in nonstatutory stock option transactions under §83 triggers the receipt of wages for purposes of withholding tax. The obligation to pay employment taxes and to withhold income taxes generally belongs to the employer. The employer will more than likely withhold FICA, Medicare and withholding from other cash compensation paid to you.
Frequently Asked Questions.
Q1. Will the grant of a Nonstatutory Option result in Federal income tax liability to me?
Q2. Will the exercise of a Nonstatutory Option result in Federal income tax liability to me if the option does not have a readily ascertainable fair market value at the date of grant?
Q3. What if the shares purchased under a Nonstatutory Option are subject to a substantial risk of forfeiture?
Q4. What is the effect of making a Section 83(b) election?
You must file the Section 83(b) election with the Internal Revenue Service within thirty (30) days following the date the option is exercised, and any ordinary income resulting from such election will be subject to applicable tax withholding requirements.
Q5. What information must be included in a Section 83(b) election?
Q6. Will I recognize additional income when I sell shares acquired under a Nonstatutory Option?
Q7. What are the Federal tax consequences to the Employer.
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Nonstatutory stock options tax reporting

If you receive an option to buy stock as payment for your services, you may have income when you receive the option, when you exercise the option, or when you dispose of the option or stock received when you exercise the option. There are two types of stock options:
Options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are statutory stock options . Stock options that are granted neither under an employee stock purchase plan nor an ISO plan are nonstatutory stock options .
Refer to Publication 525, Taxable and Nontaxable Income , for assistance in determining whether you've been granted a statutory or a nonstatutory stock option.
Statutory Stock Options.
If your employer grants you a statutory stock option, you generally don't include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO. For more information, refer to the Form 6251 (PDF). You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition. Refer to Publication 525 for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes.
Incentive Stock Option - After exercising an ISO, you should receive from your employer a Form 3921 (PDF), Exercise of an Incentive Stock Option Under Section 422(b) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income (if applicable) to be reported on your return.
Employee Stock Purchase Plan - After your first transfer or sale of stock acquired by exercising an option granted under an employee stock purchase plan, you should receive from your employer a Form 3922 (PDF), Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income to be reported on your return.
Nonstatutory Stock Options.
If your employer grants you a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined .
Readily Determined Fair Market Value - If an option is actively traded on an established market, you can readily determine the fair market value of the option. Refer to Publication 525 for other circumstances under which you can readily determine the fair market value of an option and the rules to determine when you should report income for an option with a readily determinable fair market value.
Not Readily Determined Fair Market Value - Most nonstatutory options don't have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there's no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525.