When an option is not exercised, it expires worthless. The loss on the option is treated as a capital loss and can be used to offset capital gains. The tax treatment of unexercised options depends on whether they are held as short-term or long-term assets. Short-term options are held for less than a year and are taxed at the ordinary income rate. Long-term options are held for more than a year and are taxed at the lower capital gains rate. The tax basis of an unexercised option is the amount paid for the option. When the option expires, the loss is the difference between the tax basis and the value of the option at expiration.
Consequences of Lapse
If you allow an unexercised option to lapse, you will be subject to the following tax consequences:
- The premium you paid for the option will be treated as a capital loss.
- The loss will be recognized in the year the option expires or is abandoned.
- The loss will be treated as a short-term loss if the option was held for less than one year.
- The loss will be treated as a long-term loss if the option was held for more than one year.
The tax treatment of lapsed options is the same for both call and put options.
Taxing the Advantage
Unexercised employee stock options (ESOs) are not taxed until they are exercised, but the potential gain on the options is still taxed as income when the options are exercised. This means that you will owe taxes on the difference between the strike price of the option and the fair market value of the stock on the date of exercise.
- Example: You have an ESO with a strike price of $10 per share. The stock is currently trading at $20 per share. If you exercise your option, you will owe taxes on the $10 gain per share.
The tax rate on the gain will depend on your income and filing status. If you are in the 25% tax bracket, you will owe $2.50 in taxes per share. If you are in the 35% tax bracket, you will owe $3.50 in taxes per share.
In addition to federal income taxes, you may also owe state and local taxes on the gain from your ESOs. The tax rate will vary depending on the state and locality in which you live.
| Tax Bracket | Tax Rate |
|---|---|
| 10% | $1.00 per share |
| 15% | $1.50 per share |
| 25% | $2.50 per share |
| 35% | $3.50 per share |
Capital Gains Taxation
Unexercised options are subject to capital gains taxation when they expire or are forfeited. The tax treatment of capital gains depends on several factors, including the holding period of the option and the taxpayer’s ordinary income tax rate.
When an unexercised option expires or is forfeited, the taxpayer reports a capital loss or gain on their tax return. If the option was held for more than one year, the gain or loss is considered long-term. If the option was held for one year or less, the gain or loss is considered short-term.
The tax rate for long-term capital gains is lower than the rate for short-term capital gains. For most taxpayers, the long-term capital gains rate is 15%, while the short-term capital gains rate is the same as their ordinary income tax rate.
The following table summarizes the capital gains tax rates for different holding periods:
| Holding Period | Tax Rate |
|---|---|
| Less than one year | Ordinary income tax rate |
| More than one year | 15% |
Reporting Requirements
Unexercised options are considered property for tax purposes and must be reported on your tax return.
- Form 1099-B: If you sold or exchanged unexercised options, you will receive a Form 1099-B from the broker.
- Schedule D: You will report the sale or exchange of unexercised options on Schedule D, Form 1040.
When reporting the sale or exchange of unexercised options, you must provide the following information:
| Information | Where to Report |
|---|---|
| Date of sale or exchange | Schedule D, Column (a) |
| Description of the options (including the name of the underlying security) | Schedule D, Column (b) |
| Number of options sold or exchanged | Schedule D, Column (c) |
| Sales price | Schedule D, Column (d) |
| Cost or other basis | Schedule D, Column (e) |
| Gain or loss | Schedule D, Column (f) |
Alright, that’s just about all I have on the table regarding how unexercised options are taxed. If you’re looking to dive further into the tax implications of stock options, feel free to browse through some of my other posts or articles. Thanks for taking the time to read, and please stop by again soon for more insights on personal finance and investing. Take care!