Options Trading Tutorial

Exercise ISO stock options, how is tax handled?

I am going to exercise some ISO stock options which will give me a sum of ordinary income (can't wait the year and a day for LTCG). I have the following questions which hopefully someone in the know can help me out with. Will I need to immediately file a payment to the IRS to avoid a penalty? What is the IRS form that I will need to complete and send in with my payment? (1099, 1040.....?) What is the penalty if I wait until year end and file as part my annual return? I've heard about a $100k limit on ISOs - please explain? Where can I read up and learn more about this? Thanks for your help!

Public Comments

1. There's way too much to discuss here. www.fairmark.com has everything you every wanted to know on ISOs including tax minimization strategies. IRS publication 525 is also useful. For your scenario (same day sale), you should ask them to withhold 25% for taxes if you can. The spread will be included in your W-2 *and* you will get a 1099-B at the end of the year. When you do your taxes, you will put the W-2 as is on the wage line and you will ALSO do the schedule D. Your basis on the schedule D will be the market price on the day you exercised. (With a same day sale you get a tiny loss for just the broker's fees.) DO NOT FORGET TO DO THE SCHEDULE D. Many taxpayers don't do it because they figure the income is already in the W-2 and the IRS will "know." The IRS computer is stupid. It doesn't know and if you cash out $50K of stock and forget to do the schedule D, 18 months later you will get a heart attack letter that says you forgot to report $50K of short term capital gains (the computer always uses a basis of $0) and with penalties and interest, the computer proposes that you owe $25K in tax. You don't of course, but you'll already have had the heart attack....