After a few years pass, your stock options will vest and you may owe some taxes. Earning stock options from your job can pleasantly pad your savings accounts and motivate you to stick with an employer. The stock option gives you the right to buy company stock at a fixed price, after a "vesting period" has passed.

While you wait for the options to fully vest, the stock should rise in value and the options will become more valuable. If you exercise stock options as an independent contractor, your client reports them on a form, and you'll need to let the Internal Revenue Service know as well.

The IRS allows favorable tax treatment of "statutory" stock options, on which you pay tax only when you sell the stock. A statutory stock option is one your client grants under an incentive stock option plan. For what the IRS calls nonqualified or nonstatutory stock options, income tax is due when you exercise the option to purchase the stock, which could be well in advance of the day you sell it.

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For nonqualified stock options, taxable income is generated on exercise -- the date that you actually use the option to purchase the stock. The income amount is the difference between the market price when you buy the stock and the original exercise price. You'll see the amount show up on your copy of the MISC that will arrive in January of the following year.

For a salaried, regular employee, the employer will report the compensation on Form W-2, simply adding it to the wages or salary earned during the year. In addition, the employer must withhold taxes for this income, at whatever the employee's withholding rate is. Independent contractors have no withholding from compensation reported on a , but you may need to make quarterly estimated payments to the IRS to keep up with your tax obligation.

The exercise of a nonqualified stock option can bring about a serious tax hit, even if you don't receive any cash from the transaction. You must report the compensation as business income on Schedule C and add it to your adjusted gross income on Form In addition, you must report the money on Schedule SE to calculate self-employment tax, which covers your obligation for Medicare and Social Security taxes. If you sell the shares for more than the exercise price, you've got a capital gain as well and will report that on Schedule D.

Qualified and Nonqualified Options The IRS allows favorable tax treatment of "statutory" stock options, on which you pay tax only when you sell the stock.

The Price of Exercise For nonqualified stock options, taxable income is generated on exercise -- the date that you actually use the option to purchase the stock. W-2 vs For a salaried, regular employee, the employer will report the compensation on Form W-2, simply adding it to the wages or salary earned during the year.

Who pays Social Security taxes on NQSOs?Michael Gray CPA, Stock Option Advisors

Reporting Exercise and Sale The exercise of a nonqualified stock option can bring about a serious tax hit, even if you don't receive any cash from the transaction. Non-Qualified Stock Options Fairmark: Exercising Non-Qualified Stock Options IRS. Topic -- Stock Options. Stock Options Long-Term Capital Gains Holding Period for Stock Options Stock Options vs. RSUs What Happens to a Stock Option if It Is Expired and You Don't Exercise It?

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