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I hope this is the proper board for the following issue...

I am in the process of using Turbo Tax to prepare my federal tax return and am hung-up on how to report the sale of Incentive Stock Options. By way of background, I was granted these ISO's on 12/15/2004 at a price of "P1" per share. This summer, my company was acquired by another and all options were fully vested on the closing date of the transaction for a price of "P2" per share. I filled out a form, "Notice of Cashless Stock Option Exercise", gave it to my company's finance guy, and received a check in the mail after a couple of weeks in the amount of $(P2-P1) x number of options I was granted. Nothing related to this transaction has shown up on my W2 or any other tax forms.

Anyhow...Turbo Tax is asking me what the "cost basis" is for these options. Would this be $(P2-P1) or something different?

many thank for any insight!
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Nothing related to this transaction has shown up on my W2 or any other tax forms.

Not so fast, there. At a bare minimum, you should receive a 1099-B for the sale of the stock. Technically, your cashless exercise is three different transactions that happen more or less at the same time.

1. You exercise the stock options. To do this, you need to pay the option price. But you don't put up the cash for the option price, it is just temporarily loaned to you.

2. You sell the shares acquired through the option. This is the transaction that should show up on a 1099-B. Since that form is not required to be mailed to you before Jan 31, it may still be on its way to you.

3. You repay the temporary loan used to exercise the option. That leaves you with the cash you received at the end of the cashless exercise.

Normally, a cashless exercise is also going to be reported as wages on your W-2. Further, it would be subjected to all the usual payroll withholdings - social security, medicare, federal income tax, and your state tax(es). Because you recognize this income from the cashless exercise, you get to include that income in the cost basis of your shares. That makes your basis the option price plus this income. And that total equals your sales price. So you end up with no gain or loss to report on the sale of the shares. (In practice, there is usually a commission associated with the sale, so you end up with a small loss in the amount of that commission.)

However, I think the sale of your company and being forced to exercise your options may come into play here. I'd check with your human resources department to get their take on the tax implications of this particular transaction.

Another resource for you is . They have some of the best explanations of stock options I've seen. And they have an active discussion board to help with any questions you might have after reading their stuff.

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Just my HO, and Peter knows much more than I, but I think what might be going on here is a simple sale of options. I.e. the options are never exercised, the company simply bought the options from you. Hence, the cost basis is zero (since the options were given to you for free) and the sales price is $(P2-P1)x(number of options).

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thanks very much for your replies Peter and Puss...I think I'm starting to get it...
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