Employee Stock Options

There are three classes of stock options--incentive stock options, employee stock purchase plan options, and nonqualified (nonstatutory) stock options.

Generally, incentive stock options and employee stock purchase plan options are excluded from wages both when the options are granted and when they are exercised (unless the stock is disposed of in a disqualifying disposition). However, the spread (between the exercise price and fair market value of the stock at the time of exercise) on employee stock purchase plan options is included in wages subject to social security, Medicare, and federal unemployment taxes when the options are exercised.

The spread on nonqualified options normally is included in wages when the options are exercised. (See section 1.83-7 of the regulations.) These wages are subject to social security, Medicare, and federal unemployment taxes, and income tax withholding.

For more information about employee stock options, see sections 421, 422, and 423 of the Internal Revenue Code and the related regulations.

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