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As you may know, NQSO (non qualifying stock options) have tax withheld at source as soon as you exercise, so theoretically you don’t have to pay any estimated tax on NQSO exercises/sales (although see * below).
With Incentive Stock Options (ISO) though, the situation is quite different.
It sounds like you plan to exercise and sell your ISOs on the same day. If so, then this is what’s called a “disqualifying disposition”. In other words, you will be liable for ordinary income tax on the spread (sale price – exercise price).
In general, the IRS wants you to pay tax in the quarter in which the related income is earned. So you theoretically should pay the estimated tax at your standard income tax rate in the same quarter you exercise and sell ISOs. You do this by filing an Estimated Tax payment.
However, there is a way to postpone filing these taxes until your normal April next year tax return. The following information is sourced from See http://www.fool.com/school/taxes/taxes35.htm.
1. The simplest way is just to suck it up and not worry about paying a penalty for underpayment of taxes. Depending on how much you think you can earn on your money, and when you were supposed to pay the tax, this may be a win for you (this used to happen a lot during the dotcom/IPO days of 1999-20). Be wary though that you probably can’t keep doing this year after year without the IRS getting on your case.
2. Alternatively, you can avoid the underpayment penalty *if* any of the following are true
a) you owed no tax at all in the prior tax year (and were a US citizen/resident for all of that year)
b) you expect to owe less than $10 in tax this year (unlikely, since you’re exercising ISOs)
c) your ordinary income tax withholding (e.g. from your wages and/or NQSO exercise) will exceed 90% of this year’s tax bill. This may happen if your ISO exercise/sale is less than around 10% of your total income for the year.
d) your ordinary income tax withholding (from wages and/or NQSO) is greater than 1% of your last year’s tax liability and your previous year’s Adjusted Gross Income was < $150,0. If your previous year’s AGI was >= $150,0 (lucky you), then you need to pay at least 110% of last year’s tax liability in order to avoid a tax underpayment penalty.
Clear? As mud?
Option d) is usually the easiest one to satisfy if you’re making a large ISO exercise in this year only, particularly if you got a raise this year and are hence paying more taxes than last year anyway.
However, you may also want to consider whether you should do an exercise and hold (for 1 year) to pay long term capital gains tax (15%) instead of your ordinary W2 income tax rate (probably 25-35%).
If you do, you will *still* be subject to tax this year, due to the dreaded AMT (Alternative Minimum Tax), but you can use that AMT tax liability as a credit for future years when your AMT is less than your ordinary income tax. However, that’s a topic for a whole ‘nother question/answer.
* Even with NQSOs, if the amount held at source is less than your eventual tax rate for the year, you may be subject to tax penalties unless you meet one of the exceptions listed in a) through d) above.
Source(s): http://www.irs.gov,/ http://www.fool.com/school/taxes/taxes35.htm, http://www.business2.com/b2/webguide/0,17811,23191…
I’m not a tax expert but…
It depends how much tax you owe relative to how much taxes you’ve paid, either from withholding from salary, or other estimated taxes. If you get a tax refund on April 15th, and that tax refund is equal to or greater than the tax you would owe on the gain from exercising your ISO stock options, then you don’t have to pay anything extra. Even if you owe a little bit on April 15th because of the additional income from the stock, that would be might be OK.
The important thing to understand is the IRS wants you to owe no more than 20% of your tax obligation by April 15. If you do, you’ve under-witheld your taxes and you’ll owe a penalty. In addition, if your regular salary withholding is too little, the IRS requires that you pay enough to cover your expected taxes for that QUARTER. In other words, if you make a huge gain in the first quarter of the year, you need to pay estimated taxes on that gain by the end of the quarter. You’ll owe a penalty if you were to wait until April 15th to pay the tax on the gain and if the gain was too big.
(There’s an exception for fishermen and farmers, because their income is too unpredicatable.)
The details and worksheets can be found in IRS publication 505. Also see IRS publication 17 for general information.
However, I think if you exercise your ISO options, some taxes may be withheld automatically upon excerise. The amount withheld might not be enough to pay all your taxes, but it might be enough to avoid having to pay estimated taxes.
If you use Turbotax or some such tax program, it can help you figure out your estimated taxes.
Source(s): http://www.irs.gov/pub/irs-pdf/p505.pdf
I filed on 2/5 and accepted on 2/5.. Still no dd and we are still not able to order my transcripts I have not seen anyone else from different websites that have filed after feb 4 th get a dd yet. It seems that peeps from jan 30 thru feb 4 who filed got dd this week anywhere from feb 12 or 13.. I spoke to an actual IRS rep yesterday on the phone and he said everything was perfect with my return he saw no issues and that I just need to give them time to finish up! But honestly this is frustrating maybe we will all get a dd today on wmr site for the 14 or 15 or 16th… Keeping my fingers crossed good luck everyone