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I know that if a person sells stock bought on an ISO before the one year holding period ends, the "spread" at the date of exercise is taxed as income.

My question is, how does the IRS know that the stock sold was purchased under an ISO? I know that the employee is supposed to notify the company if the stock is sold before the one-year holding period. Is this where the IRS gets informed?
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tdel: My question is, how does the IRS know that the stock sold was purchased under an ISO? I know that the employee is supposed to notify the company if the stock is sold before the one-year holding period. Is this where the IRS gets informed?

I was hoping that somebody else would volunteer to answer this, but no one has so.......

Without specific knowledge of the law, I'm under the impression that the company is obligated to let the IRS know of disqualifying dispositions, probably as part of the statute that enables and defines "qualified."

Certainly with other benefits and compensation matters, 401(k) plans and the like, if a company fails to comply with the rules the allow the establishment of these plans, they can lose -- for all employees -- the favorable tax treatment accorded to such plans. It wouldn't surprise me at all to know that this is true for this.

Assuming they issued you a certificate for shares, however, you can rest assured that they know (or have the ability to know) if you've disposed of that certificate whether or not you notify them. My company, for one, contacts us and asks us to show (by means of a brokerage statement) that all we've done is transfer shares we still hold to a "street name" -- i.e., to our own account in a brokerage's street name -- and that we still have beneficial ownership. In the absence of such evidence, the assumption is that you have sold it, and it will be reported.

mathetes
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tdel: My question is, how does the IRS know that the stock sold was purchased under an ISO? I know that the employee is supposed to notify the company if the stock is sold before the one-year holding period. Is this where the IRS gets informed?

mathetes: Without specific knowledge of the law, I'm under the impression that the company is obligated to let the IRS know of disqualifying dispositions, probably as part of the statute that enables and defines "qualified."

Hi, mathetes. This is one of the (very) few times I disagree. While the company may ask, the auditing on ISO's doesn't seem to extend any further. Once I transferred my stock to another broker, there's no trail back from there. In fact, this broker specifically checked the certificates for any limitations and found none.

I believe the only traceability is that establishing the normal "basis of assets" on your end. And, of course, your exercise of ISO stock is (must be) directly reported to the IRS by the company, and your company should give you an EOY summary on this. Since you may also have other stock, the whole thing comes down to establishing the basis.
--kanab


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