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Hi all,

I know that if you exercise options and sell them the same day, it counts as ordinary income for tax purposes.

How do you handle that, though? Do you pay quarterly estimated taxes, and if so, given an exercise date in this week, would April 15 be the first quarterly payment? Do you do a lump payment to cover the estimated taxes for the year?

Thanks for any advice,

Hilary
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I know that if you exercise options and sell them the same day, it counts as ordinary income for tax purposes.

Are you talking about options related to your employment, such as ISOs?

If so, its not only ordinary income, it's also wages. Your employer will withhold income tax, social security tax and medicare tax as part of the exercise and sale. You won't need to worry about estimated tax payments.

Instead, you'll need to worry about making sure an appropriate amount of income tax is withheld. ;-)

And don't forget this is really two transactions - both the acquisition and sale of the stock. You'll have to report the sale on your tax return next year. So watch for a 1099B and make sure you know what to report as the cost of the stock. Your HR department will probably give you everything you need to figure out the correct cost. (Hint - it's probably the sale price before paying any sale commission and fees.)

--Peter
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Are you talking about options related to your employment, such as ISOs?

If so, its not only ordinary income, it's also wages. Your employer will withhold income tax, social security tax and medicare tax as part of the exercise and sale. You won't need to worry about estimated tax payments.


But the employer may withhold income tax from the sale of options at a rate much lower than the OP's actual tax rate. During the tech boom we had taxes on options withheld at 25% while the options income pushed us into the 39.6% bracket. If you're not aware of the difference, it can come as a shock the following April 15, especially if you've spent the income.

--fleg
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To avoid a penalty for underpayment, presuming your total income/tax will be higher in 2010 because of the options sale, be sure your withholding through April 15, 2010 and any installment you pay on April 15, 2010 total at least 1/4 of your 2009 total tax (1/4 of 110% of last year's tax if last year's AGI was over $150K). The same will apply for each subsequent quarter. You will probably owe considerable tax to pay in April 2011, but no penalty. In other words: You don't have to pay the tax when you get the income, and you can spread it out and defer it considerably.

The installments are due April 15, June 15, September 15 and January 15. Note the "quarters" are not all 3 months long and the first quarter contains 3 1/2 months of withholding so your first quarter installment might be less than subsequent quarters because it contains more withholding (3 1/2 months), and the second quarter only contains 2 months of withholding so that quarter's instalment will be more. Note this works to your advantage and is an option instead of considering withholding averaged evenly across all 4 quarters.

Due to the surge in income in the first quarter, and presuming your regular income continues, since your tax will be higher than last year and most of your income comes in the first quarter, the other "safe harbors" are not likly to help you (that is, paying the least amount necessary during 2010 to avoid a penalty).

Get IRS form 2210 to see how this works.

ed
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Thanks! This was helpful!
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