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How to Use an Online Tax Calculator
Tax calculators are useful for those who would like to know information about their take-home pay after deductions occur. There are many other types of tax calculator online free you can use depending on if you would like to calculate capital gains, self-employment tax, pensions, charitable taxes, and so on.
Here are some tips you should follow to learn how to use a free tax calculator IRS so you can determine more information about your deductions and returns.
Using an Income Tax Calculator
A tax calculator for salary works by entering your salary into the field and, if you know it, the tax code. Enter the number of hours you work for overtime each month into the tax for salary calculator. For example, if you work five hours of overtime monthly at time and a half, you would enter that into the calculator as five at one and a half hours. Then, you select your filing status as single (“individual”), married filing jointly, married filing separately, or the head of the household. Lastly, choose the number of dependents excluding yourself and your spouse.
Using a Federal Income Tax Calculator
Every resident of the United States must pay Federal income taxes. Therefore, it’s helpful to know what your refund estimate is going to be when filing your taxes. Use of an IRS withholding tax calculator will help you calculate and prepare for how your tax bill will be when you file your taxes. You can use this tax calculator to calculate personal taxes as well as a self employed calculator depending on which tab you select. If you opt to use the tax on salary calculator as a self-employed business, enter the total company pass-through income, total company assets, total company W-2 wages, and click calculate to use it as a working tax credit calculator. An Ontario payroll calculator will be different because it’s operating outside of the United States.
Using Income Tax Calculator by State
Each state has a separate tax calculator free online available, like a tax calculator in California, for example. Enter your household income into the first field of this simple form calculator, the location is already entered into the second field for you for the state, and enter your filing status from the drop-down menu. You can use advanced criteria including 401(k) contribution, IRA contribution, itemized deductions, and the number of personal exemptions. The calculator will present your estimated state income tax.
Using Other Tax Calculators
It’s possible to find a myriad of other tax calculators online for free. For example, if you need to determine the taxes on your pensions, there’s a tax on pensions calculator. The pension tax calculator is an excellent tool to use year-round to stay on top of your finances. A tax calculator on lump sum is another useful tool if you made a large donation or gifted a significant amount to a group or individual. If you have questions about land transfers that you conducted during the tax year, use a land transfer tax calculator. There are also capital tax gains calculator and charitable annuity calculator for those who have questions about those line items on their taxes.
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How are Options Taxed?
Options trading is becoming more popular among investors, yet a lot of people don't understand the tax implications of these transactions. Investors may be surprised by how complex the taxation of options can be. Let's look at the key factors you need to consider when it comes to buying and selling options on the open market.
The language of taxes versus investing
The IRS has its own lingo when it comes to investing, which doesn't match up perfectly with the language used within the financial industry. Though many people may consider themselves to be "traders" (aka day traders or active traders), to the IRS, you're likely just seen as an "investor." To be considered a trader by the IRS you must be in the "business of trading," which basically means trading is your day job.
This article will focus on the tax implications of buying and selling options for "investors." For those who feel they may qualify as being in the "business of trading," we recommend meeting with a tax professional and reading the following IRS resources, IRS publication 550 and IRS Topic No. 429 Traders in Securities .
Categories of options
For tax purposes, options can be classified into three main categories:
- Employee stock options: These are generally options contracts given to employees as a form of compensation. For example, incentive stock options.
- Equity options: Options contracts on equities that can be traded on the open market. For example, puts or calls on individual stocks or on ETFs that hold stocks.
- Non-equity options: As the name infers, these are options contracts on something other than equities or ETFs, which can include commodities, futures or a broad-based stock market index. The IRS often refers to these options as " section 1256 contracts ." These types of options can also be traded on the open market. Examples include puts or calls on gold, pork belly futures, and even the S&P 500 index (more on this later).
Taxation of employee stock options
Though employee stock options aren't traded on the open market, they are a common form of option held by many people. Here are a few high-level points you should know about them. These option contracts are usually granted by an employer to attract new employees, or to reward and retain current ones. There are two primary types of employee stock options: non-qualified stock options and incentive stock options.
Generally, the gains from exercising non-qualified stock options are treated as ordinary income, whereas gains from an incentive stock option can be either treated as ordinary income or can be taxed at a preferential rate, if certain requirements are met. To learn more about employee stock options, see " How Should Equity Compensation Fit Into Your Financial Plan " and " Understanding the Risks of Employee Stock Options ."
Taxation of equity options
The taxation of equity options is different for a long position (where you're the buyer of the option) versus a short position (where you're the seller/writer of the option). For those who have long or short options contracts, the tables below provide an overview of how these contracts are generally taxed. But be aware, if you're doing more complex options transactions, such as spreads or butterflies, the IRS may consider those trades to be "straddle" contracts, which means they could be taxed differently (see below for more details).
Long options
- Long Options (buy)
- If position is closed before the expiration
- If you exercise the option
- If the option expires
- Long Options (buy) Long Call
- If position is closed before the expiration The holding period of the option determines if it's taxed at short- or long-term capital tax rates.
- If you exercise the option Exercising a call option increases the cost basis of the stock purchased. There is not a taxable event until stock is sold, and the hold period of the stock determines if the capital gain or loss is short- or long-term.
- If the option expires The holding period of the option determines if the capital loss is short- or long-term.
- Long Options (buy) Long Put
- If position is closed before the expiration Same as above.
- If you exercise the option Exercising a put option reduces the amount realized from the sale of the underlying stock by the cost of the put.
- If the option expires Same as above.
Short options
- Short Options (sell/write)
- If the option is exercised (assigned to you)
- Short Options (sell/write) Short Call
- If position is closed before the expiration Regardless of holding period, the capital gain or loss is always considered short-term.
- If the option is exercised (assigned to you) The amount you received for writing the option increases the amount received from the sale of the stock. Depending on your holding period of the stock, the capital gain or loss is short- or long-term.
- If the option expires Report the amount received for writing the option as short-term capital gain.
- Short Options (sell/write) Short Put
- If the option is exercised (assigned to you) If the put option is exercised and you buy the underlying stock, decrease the cost basis in the stock by the amount received for writing the option. Your holding period for the stock begins on the date you buy it.
- If the option expires Same as above.
Taxation of complex equity options strategies
Numerous options strategies are available to investors, such as writing covered calls, using spreads, straddles, strangles, butterflies, etc. Unfortunately, this is another situation where the IRS does not use the same language as investors, and that can lead to some confusion. The IRS groups most of these complex options strategies together and refers to them as a "straddle."
For tax purposes, a straddle occurs when you're holding an options contract that offsets or substantially reduces the risk of loss to another position you're also holding. For example, say you own stock in XYZ corporation and that stock in currently trading for $80 per share. If you bought a put option at a $70 strike price to protect against downside price movement, you have in essence limited your down-side risk, which means the IRS would consider that option to be a straddle and you must defer your loss (cost) on the put option. The idea behind the straddle taxation rules is to prevent investors from deducting losses before an offsetting gain is recognized.
Here are the basics you need to know about how straddles are taxed:
- Losses on straddles are generally deferred: If only one side of a straddle position is closed, any realized losses are generally not deductible until the offsetting position is also closed out. Any losses are included in the basis of the remaining position and eventually recognized when the final position is closed. Note: Any loss that exceeds the unrecognized gain from an offsetting position can generally be deducted.
- Qualified covered calls (QCCs) are not subject to the straddle rules: The IRS groups covered calls into two categories, unqualified or qualified, and each is taxed differently. Generally, QCCs are options written with an expiration date greater than 30 days and a strike price that is not "deep-in-the-money" (see IRS Publication 550 to learn more). If the covered call does not meet these requirements, then it's considered "unqualified" and is taxed as a straddle.
- Offsetting section 1256 options are exempt from this rule: Straddles consisting entirely of Section 1256 options are not taxed as straddles (see more below).
The wash sale rules generally apply to options
The same wash sale rules that apply to stock also apply to stock option trades. If a substantially identical security is acquired within 30 days before or after the sale occurs, the loss is disallowed and the basis is transferred to the new position.
Non-equity options taxation
Internal Revenue Code section 1256 requires options contracts on futures, commodities, currencies and broad-based equity indices to be taxed at a 60/40 split between the long and short term capital gains rates. This rule means the taxation of profits and losses from non-equity options are not affected by how long you hold them. Section 1256 options are always taxed as follows:
- 60% of the gain or loss is taxed at the long-term capital tax rates
- 40% of the gain or loss is taxed at the short-term capital tax rates
Note: The taxation of options contracts on exchange traded funds (ETF) that hold section 1256 assets is not always clear. Consult with a tax professional if you hold these types of investments.
In addition to the 60/40 split rule, if you hold section 1256 options contracts over year-end into the new year, you'll be required to recognize an unrealized gain or loss each year based on the fair market value on Dec. 31. This is known as the marked-to-market rule, and it applies even if you don't sell that option. This activity also resets your cost basis (higher or lower) for the next calendar year. In addition, section 1256 contracts are not subject to the same wash sale rules as equity options.
Bottom line
The taxation of options can be even more complex than what was described above. That's why we recommend that anyone who trades options consider working with a tax professional who has experience in options taxation so that you don't end up paying more in taxes than is necessary.
Just getting started with options?
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Related topics.
Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled " Characteristics and Risk of Standardized Options ." Supporting documentation for any claims or statistical information is available upon request.
With long options, investors may lose 100% of funds invested.
Multiple leg online option orders such as spreads, straddles, combinations, and rollouts are charged per contract fees for the total number of option contracts. Complex online option orders involving both an equity and an option leg, including Buy/Writes or Write/Unwinds, are charged per-contract fees for the option leg. Service charges apply for trades placed through a broker ($25) or by automated phone ($5).
Covered calls provide downside protection only to the extent of the premium received and limit upside potential to the strike price plus premium received.
Uncovered options strategies involve potential for unlimited risk, and must be done in margin accounts.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Important: tastyworks has changed its name to tastytrade.
Taxes on options exercises, assignments, and rolls
Booking profits or losses from buying to close a short position or selling to close a long position is pretty straightforward, but how is it treated when you exercise an option or if you get assigned? Options can be complicated but add tax treatment to it, and you wind up with one complex cocktail. That's why we've broken it down below.
Review of exercise and assignment of puts and calls
Assignments from short options, exercising long options, rolling trades, tax treatment for exercise, assignments, and rolling trades.
Before we get started, let's do a refresher and review the differences between a call or put assignment versus an exercise.
The resulting position from an assignment and exercise differs from calls and puts. Remember, assignment is the term to use when you are short an option. Exercise is the term to use when you are long an option.
Your cost basis or proceeds are affected based on your position type. Any commissions or fees from the original trade and assignment fees will also factor in your overall p/l. The cells shaded yellow are affected by an assignment when you are assigned.
Like an assignment, your cost basis or proceeds are affected based on your position type. Any commissions or fees from the original trade and assignment fees will also factor in your overall p/l.Cells shaded yellow are affected by an exercise.
Rolls, on the other hand, are a bit different. Even though you may not have closed out of your rolled position, you realize a gain or loss each time you roll. A rolling trade consists of closing a position and realizing a profit or loss, then opening a new position in its place. When you roll a short premium or long premium position, the closing portion of the roll would be a realized loss or profit, which is a taxable event. Even though the position is not closed in your eyes, rolls, by definition, are a taxable event. Your overall realized profit from a short premium position will only occur if you cover it for less than the total credits received. Conversely, long premium trades can only be realized as an overall profit if sold for more than the total debit paid.
- Taxes FAQ for International Accounts
- Position Reporting for End of Year Taxes
- How to Report Section 1256 Contracts (Futures and Cash-Settled Index Options)
- Tax Form Corrections
- Short-Term vs. Long-Term and 1256 Contracts
- Consolidated 1099 Guide
- Tax Form Calendar
- Form 1042-S Guide (for International Accounts)
- Tax Withholding Rates for International Customers
- International ID Number
Taxes on options exercises, assignments, and rolls Print
Modified on: Mon, 20 Dec, 2021 at 1:04 PM
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Options Tax Guy
Assignment & Exercise
So what is the process of Assignment and Exercise?
There are a particular set of rules regarding assignment and exercise of options. Those rules are generally enforced by the Options Clearing Corporation ( OCC ).
Remember, with American style options, the holder of the option has the right to exercise that option at any time before the option expires.
What we are concerned with here is only the automatic exercise of option contracts because that process affects cost basis in the underlying stock. With automatic exercise , generally the OCC will automatically exercise any expiring equity option (call or put) if it is at least $0.01 in-the-money .
What does that mean?
Long : If you purchased (BTO) a call on Apple with a strike price of 150 that expires in August of 2017 and Apple closes on expiration Friday at $150.01 or higher, you will automatically be assigned shares of Apple based on the number of calls held. In other words, if you held 1 contract, you will now purchase 100 shares of Apple at $150 per share.
Short : If you sold (STO) a call on Apple with a strike price of 150 that expires in August of 2017 and Apple closes on expiration Friday at $150.01 or higher, you will automatically be forced to deliver 100 shares of Apple stock to the holder/buyer of that call option. If you do not already own the shares (a naked call position) you will have to purchase the shares at the market price when the market opens. If you already own the shares (a covered call position), 100 of your Apple shares will be delivered to the holder of the call option.
Long : If you purchased (BTO) a put on Apple with a strike price of 150 that expires in August of 2017 and Apple closes on expiration Friday at $149.99 or lower, you will automatically be short Apple shares based on the number of puts held. In other words, if you held 1 contract, you will be short 100 shares of Apple at $150 per share. You can now “cover” your position by purchasing 100 Apple shares in the market at presumably a price lower than $150. However, there is the obvious weekend risk associated with being short stock, which is beyond the scope of this discussion and subject to your broker’s rules.
Short : If you sold (STO) a put on Apple with a strike price of 150 that expires in August of 2017 and Apple closes on expiration Friday at $149.99 or lower, you will automatically be obligated to purchase 100 shares of Apple stock from the holder/buyer of that put option. This is called a naked put position and is a great way to get into a stock at a lower price, assuming you have the cash in your account to facilitate the purchase - a cash-secured naked put.
What are the tax implications of automatic assignment or exercise?
Contrary to some opinions, options CAN impact the cost basis of your underlying stock positions . So how can that happen if they are separate securities? Let’s look at some examples:
Example 1 - Assigned Puts :
In December 2016 American Airlines (AAL) is trading at $46 per share. You believe it could go higher but you don’t want to purchase the stock at the current price. You sell 10 Mar 2017 42.50 puts (naked, but cash secured) for $0.60 per contract and bring in $600 premium (ignoring commissions). At March expiration, AAL has dropped to $41.72 per share and you are assigned the stock for $42.50. Your basis in those shares is not the $42.50 purchase price but $41.90 ($42.50 strike price minus the $0.60 received from selling the put). Also, as described above, the premium for selling that put in December is not income in 2016 but decreases the cost basis in the stock purchased in March, which is also when the holding period begins.
What happens to the put originally sold? It is NOT reported on your tax return!! The underlying stock price “absorbs” the premium into its new cost basis.
Essentially, this treatment has the potential to turn what would have been a short-term capital gain into a long-term gain. If the assigned shares are held more than one year, the premium received from the sale of the put is now buried in the basis of the stock which is subject to long-term capital gain treatment - a result which I believe was unintended by Congress.
Example 2 - Exercised Calls :
In March 2017 McDonalds (MCD) is trading around $130. You believe it has the potential to go higher by the end of 2017 and buy to open (BTO) a call option on MCD with a strike price of 140 and an expiration in April 2017. On the April 2017 expiration date, MCD closes at $133.41 and you are assigned shares. The option originally cost $0.95 so your basis in MCD is now $130.95 per share ($130 strike price + $0.95 paid for the call option).
What happens to the call originally purchased? It is NOT reported on your tax return!! As in the previous example, your basis for gain or loss has been increased by the price paid for the call.
Download the following Table as an Adobe pdf by clicking here
Example 3 - Exercised Put
In October 2016 Allergan PLC (AGN) is trading around $235 but you believe it is overpriced. You purchase a put with a strike price of 200 for the November 2016 expiration cycle. AGN closes at $191.78 on expiration Friday and you are exercised. You are now short 100 shares of AGN which you sold for $200. Assume you paid $1.50 for the put and you buy to cover your short sale for $188 when the market opens the following Monday. Your basis for gain or loss is $188.00 ($188 buy to cover) and your net proceeds from the short sale are $198.50 ($200 strike - $1.50 cost of the put). Therefore, your gain is $10.50 per share ($198.50 less $188 basis) or a total of $1,050.
Example 4 - Assigned Call
In June 2017 you purchase Gilead Sciences (GILD) on a dip for $65 and then sell a September 2017 70 call for $1.25. The closing price on the September expiration day is $82.36 and your shares are assigned at $70 - you forego the gain from $70 to $82.36. Your basis for gain or loss is $65 and the proceeds from the sale are $71.25 ($70 strike price + $1.25 received for the call).
However, this treatment may not agree to the gross proceeds on Form 1099B. You will achieve the same result by reporting these two transactions separately. This treatment is illustrated, in part, with the video on the Apple covered call adjusted into a collar, which you can view here or on the section explaining how to report Trading Strategies.
Holding Period Adjustment
So, while we’re on the subject of Assignment and Exercise, when an underlying is either assigned or exercised, or in this case, you now own the stock or ETF, when does the holding period for that underlying begin?
Does it begin on the date the option is purchased or written (short)?
Does it begin on the day of the assignment/exercise?
The answer is actually neither. The holding period begins on the day AFTER the exercise/assignment. The holding period for the option ends on the day of assignment/exercise.
Therefore, you hold a short put that expires 7/19/2014. The underlying drops into the money (ITM) and you are assigned the shares. Since the expiration date of the option is technically on Saturday, the first day of the holding period for the underlying would be Sunday, 7/20/2014 - a non-business day in which the market is not open.
Conclusion : In the previous example, there are two securities with two distinct holding periods:
The option contract has a holding period beginning on the day the contract was entered into and ending on the Saturday following the third Friday (assuming a regular option), and
The underlying security whose holding period begins on the day AFTER the assignment or exercise.
Also, keep in mind that there could also be wash sale implications for various holding period scenarios.
Does This Really Matter?
Well, actually, it does and it doesn’t.
It Does - IRS Publication 550 explains how exercised and assigned shares should be reported as to proceeds and basis, as reflected above. However, not every brokerage firm complies with Pub 550, and you do not want to ignore IRS rules, at least not without a good reason - which translates to having substantial authority that is contrary to the rule.
It Doesn’t - Whether one reports the exercise of long options and assignment of short options according to the instructions contained in Pub 550 or not, the ultimate gain or loss is the same - the timing could be different.
So what should I do?
In my opinion it depends on the broker. If a taxpayer reports amounts which disagree with what a broker reports to IRS it must be explained in the ‘ Adjustment ’ column of Form 8949. So, if a trader is assigned shares via a short put and adjusts the basis of the underlying down by the proceeds received from the sale of the put and the broker does not report the basis decrease, an adjustment results. But, the broker would report the sale of the put and a buy to close at zero, resulting in a gain that exactly offsets the basis reduction. In this scenario, there is a possible detrimental impact on the taxpayer as explained above in Example 1 - a holding period adjustment.
Aren't Brokers Required to Adjust Basis and Proceeds?
Since the brokers have been required to adjust basis for put/call assignment and exercise since 2014, basis and proceed adjustment has not been as much of a problem as it was prior to 2014.
Where it becomes problematic is when there have been wash sale adjustments. Wash sales impact the cost basis of the substantially identical security purchased. Therefore, even though the adjusted proceeds - from the sale of a call - the cost basis may not agree with you records. Thus, there could be multiple adjustments necessary, including basis, proceeds and holding period.
Further, sometimes there are just errors ... which makes it incumbent upon the taxpayer to keep very accurate records pertaining to assignment, exercise and wash sales in order to file a true, complete and accurate tax return.
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Tax implications of covered calls
- Options Strategies
Overview of tax issues
The following discussion is a broad overview of some of the tax issues that investors who use covered calls should be aware of. Any information contained herein is not intended to be tax advice and should not be considered as such. Tax laws relating to options in general and covered calls specifically are subject to change, so you should seek the advice of a tax professional to make sure you are complying with current IRS regulations.
The information provided in this section is a summary of only a few points discussed in publications by The Options Industry Council.
Profits and losses attained from covered calls are considered capital gains. Gains and losses can come from the stock only, from the covered call only, or from a combination of the 2. A gain on a stock is realized when it is sold at a higher net price than the net price at which it was purchased. A loss on a stock is realized when the net sale price is lower than the net purchase price.
For covered calls in which the sale of the call comes first, a gain is realized when the call is repurchased at a lower net price than the net sale price. A loss on a covered call is realized when it is repurchased at a higher net price than the net price at which it was sold.
If a covered call is assigned, then the entire net profit or net loss is determined by the net purchase price and net sale price of the stock as discussed below.
One major concern for investors who use covered calls is the holding period of the stock, and some covered calls affect the holding period of the stock.
Dividends paid by the stock may also be a benefit of the covered call strategy, and some dividends qualify for favorable tax treatment if a stock is held for 61 days during the 121-day period beginning 60 days before the ex-dividend date and ending 60 days after the ex-dividend date. Since some covered calls affect the holding period of the stock, however, it is possible that the tax treatment of dividends might be affected.
Tax treatment of covered calls
According to Taxes and Investing , the money received from selling a covered call is not included in income at the time the call is sold. Income or loss is recognized when the call is closed either by expiring worthless, by being closed with a closing purchase transaction, or by being assigned.
If a call expires worthless, the net cash received at the time of sale is considered a short-term capital gain regardless of the length of time that the short call position was open.
If a covered call is closed with a closing purchase transaction, the net capital gain or loss is considered short term regardless of the length of time that the short call position was open.
If a covered call is assigned, the strike price plus the premium received becomes the sale price of the stock in determining gain or loss. The resulting gain or loss depends upon the holding period and the basis of the underlying stock. If the stock delivered has a holding period greater than one year, the gain or loss would be long term.
Qualified covered calls
The information used to calculate the actual dollar amount is useful for other reasons as well. This information is needed to draw a profit-loss diagram. It is also necessary to calculate important aspects of a covered call position such as the maximum profit potential, the maximum risk potential, and the breakeven point at expiration.
Tax straddle rules are intended to prevent taxpayers from deducting losses before offsetting gains have been recognized. Although tax straddle rules are simple in theory, they are complex in practice because they can apply in unexpected situations and cause adverse tax effects. Fortunately, tax straddle rules do not apply to "qualified covered calls."
A qualified covered call is a covered call with more than 30 days to expiration at the time it is written and a strike price that is not "deep in the money." The definition of "deep in the money" varies by the stock price and by the time to expiration of the sold call.
Possible impact on taxable holding period of the stock
According to Taxes and Investing (page 23), "Writing an at-the-money or an out-of-the-money qualified covered call allows the holding period of the underlying stock to continue. However, an in-the-money qualified covered call suspends the holding period of the stock during the time of the option’s existence.
"Further, any loss with respect to an in-the-money qualified covered call is treated as a long-term capital loss, if at the time the loss is realized, the gain on the sale of the underlying stock would be treated as a long-term capital gain.
"Additionally, when a covered call is disposed of at a loss in one tax year and the stock is sold for a gain in the subsequent tax year, the stock must be held at least 30 days from the date of the disposition of the call in order to avoid application of the loss deferral rule…"
Let's look at an example:
Tax treatment:
- The investor is not entitled to the 15% rate on the dividend, because the stock was not held for 61 days during the required 121-day period.
- The stock was deemed to be held from September 9 to October 13 (34 days) and from November 14 to December 2 (17 days) for a total of 51 days.
- The period from October 13 to November 14 is not included in the holding period because of the in-the-money covered call.
Note: Writing an at-the-money or out-of-the-money covered call allows the holding period of the stock to continue. In the example above, had a 42.50-strike call or a 45-strike call been written with the stock price at $41, then the investor would have met the holding period requirement to be eligible for the lower tax rate of qualified dividends.
Covered calls that are NOT qualified
Covered calls that do not meet the definition of a qualified covered call generally are subject to the tax straddle rules, which are intended to prevent taxpayers from deducting losses before offsetting gains have been recognized. Positions are considered to be "offsetting" if they "substantially diminish" the risk of loss on another position.
If a multiple-part position is subject to the tax straddle rules, the consequences include the following:
- If a non-qualified covered call is sold against a stock position that was held less than one year, then the holding period for that stock is terminated.
- If both the stock and covered call are closed at the same time, then the net capital gain or loss is treated as short term.
- If the call is closed first, then a new holding period for the stock begins on the day that the covered call is closed.
- No current deduction for losses to the extent of the unrealized gain at the end of the taxable year.
Assignment of covered calls and holding period of stock
Assignment of covered calls results in the sale of the underlying stock. To calculate the appropriate tax, an investor needs to know the purchase price, the holding period, and the sale price. For tax purposes, when at-the-money or out-of-the-money qualified covered calls are assigned, the sale price of the stock is equal to the strike price of the call plus the net premium received for selling the call.
The sale of an at-the-money or out-of-the-money covered call does not affect the holding period of the underlying stock. However, the sale of an in-the-money qualified covered call suspends the holding period. Let's look at 2 examples.
Tax treatment: The stock sale is treated as long term, because the option was a qualified covered call when it was sold.
- The stock sale is treated as short term, because the option was an in-the-money qualified covered call.
- As a result, the holding period of the stock for tax purposes was from January 2 to November 16, which is less than one year.
- The in-the-money qualified covered call suspended the holding period of the stock.
Covered calls, stock holding periods, and qualified dividends
Dividends paid by the stock may also be a benefit of the covered call strategy, and some dividends qualify for favorable tax treatment if a stock is held for 61 days during the 121-day period beginning 60 days before the ex-dividend date and ending 60 days after the ex-dividend date, and the holding period must be satisfied for each dividend payment. "Days held" are calculated from the date the stock is sold, and they do not have to be continuous. The tax rate for "qualified dividends" is 15% for most tax filers, but can rise to 20% for filers in the higher taxable income ranges.
Note : Writing an at-the-money or out-of-the-money covered call allows the holding period of the stock to continue. In the example above, had a 42.50-strike call or a 45-strike call been written with the stock price at $41, then the investor would have met the holding period requirement to be eligible for the lower tax rate of qualified dividends.
Key takeaways
Investors who use covered calls should seek professional tax advice to make sure they are in compliance with current rules.
Profits and losses from covered calls are considered capital gains.
Qualified covered calls generally have more than 30 days to expiration and are either out-of-the-money, at-the-money, or in-the-money by no more than one strike price. However, special rules apply to longer-dated options (options with more than 12 months to expiration).
In-the-money qualified covered calls suspend the holding period of the stock that has been held for less than one year while the call is open, and non-qualified covered calls terminate the holding period of such stock (the holding period starts over when the non-qualified covered call is closed).
The tax treatment of dividends may also be affected by covered calls.
Next steps to consider
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Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please read Characteristics and Risks of Standardized Options . Supporting documentation for any claims, if applicable, will be furnished upon request.
There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared with a single option trade.
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Exercising Options
Pure options plays, covered calls, qualified vs. unqualified treatment, protective puts, wash sale rule, the bottom line.
Options and Derivatives
Tax Treatment for Call and Put Options
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It is crucial to build a basic understanding of tax laws prior to trading options . In this article, we will examine how calls and puts are taxed in the United States. Namely, we will look at calls and puts that are exercised, as well as options that are traded on their own. We will also discuss the wash sale rule and the tax treatment of straddles .
Before going any further, please note the author is not a tax professional. This article should serve only as an introduction to the tax treatment of options. Further due diligence or consultation with a tax professional is recommended.
Key Takeaways
- If you're trading options, chances are you've triggered some taxable events that must be reported to the IRS.
- While many options profits will be classified as short-term capital gains, the method for calculating the gain (or loss) will vary by strategy and holding period.
- Exercising in-the-money options, closing out a position for a gain, or engaging in covered call writing will all lead to somewhat different tax treatments.
Call Options
When call options are exercised, the premium paid for the option is included in the cost basis of the stock purchase. Take for example an investor who buys a call option for Company ABC with a $20 strike price and June 2020 expiry. The investor buys the option for $1, or $100 total as each contract represents 100 shares. The stock trades at $22 upon expiry and the investor exercises the option. The cost basis for the entire purchase is $2,100. That's $20 x 100 shares, plus the $100 premium, or $2,100.
Let's say it is August 2020 and Company ABC now trades at $28 per share. The investor decides to sell their position. A taxable short-term capital gain of $700 is realized. That's $2,800 in proceeds minus the $2,100 cost basis, or $700.
For the sake of brevity, we will forgo commissions, which can be included in the cost basis. Because the investor exercised the option in June and sold the position in August, the sale is considered a short-term capital gain, as the investment was held for less than a year.
Put Options
Put options receive a similar treatment. If a put is exercised and the buyer owned the underlying securities, the put's premium and commissions are added to the cost basis of the shares. This sum is then subtracted from the shares' selling price. The position's elapsed time begins from when the shares were originally purchased to when the put was exercised (i.e., when the shares were sold).
If a put is exercised without prior ownership of the underlying stock, similar tax rules to a short sale apply. The time period starts from the exercise date and ends with the closing or covering of the position.
Both long and short options for the purposes of pure options positions receive similar tax treatments. Gains and losses are calculated when the positions are closed or when they expire unexercised. In the case of call or put writes, all options that expire unexercised are considered short-term gains . Below is an example that covers some basic scenarios.
Taylor purchases an October 2020 put option on Company XYZ with a $50 strike in May 2020 for $3. If they subsequently sell back the option when Company XYZ drops to $40 in September 2020, they would be taxed on short-term capital gains (May to September) or $10 minus the put's premium and associated commissions. In this case, Taylor would be taxed on a $700 short-term capital gain ($50 - $40 strike - $3 premium paid x 100 shares).
If Taylor writes a call $60 strike call for Company XYZ in May, receiving a premium of $4, with an October 2020 expiry, and decides to buy back their option in August when Company XYZ jumps to $70 on blowout earnings, then they are eligible for a short-term capital loss of $600 ($70 - $60 strike + $4 premium received x 100 shares).
If, however, Taylor purchased a $75 strike call for Company XYZ for a $4 premium in May 2020 with an October 2021 expiry, and the call is held until it expires unexercised (say Company XYZ will trade at $72 at expiry), Taylor will realize a long-term capital loss on their unexercised option equal to the premium of $400. This is because he would have owned the option for more than one year's time, making it a long-term loss for tax purposes.
Covered calls are slightly more complex than simply going long or short a call. With a covered call, somebody who is already long the underlying security will sell upside calls against that position, generating premium income but also limiting upside potential. Taxing a covered call can fall under one of three scenarios for at or out-of-the-money calls:
- Call is unexercised
- Call is exercised
- Call is bought back (bought-to-close)
For example:
- On Jan. 3, 2019, Taylor owns 100 shares of Microsoft Corporation ( MSFT ), trading at $46.90, and writes a $50 strike covered call, with September 2020 expiry, receiving a premium of $0.95.
- If the call goes unexercised , say MSFT trades at $48 at expiration, Taylor will realize a short-term capital gain of $0.95 on their option, even though the option was held for more than one year. When a put or call option expires, you treat the premium payment as a short-term capital gain realized on the expiration date regardless of the holding period.
- If the call is exercised , Taylor will realize a capital gain based on their total position time period and their total cost. Say they bought shares in January of 2020 for $37, Taylor will realize a short-term capital gain of $13.95 ($50 - $36.05 or the price they paid minus call premium received). It would be short-term because the position was closed prior to one year.
- If the call is bought back , depending on the price paid to buy the call back and the time period elapsed in total for the trade, Taylor may be eligible for long- or short-term capital gains/losses.
The above example pertains strictly to at-the-money or out-of-the-money covered calls. Tax treatments for in-the-money (ITM) covered calls are vastly more intricate.
When writing ITM covered calls, the investor must first determine if the call is qualified or unqualified , as the latter of the two can have negative tax consequences. If a call is deemed to be unqualified, it will be taxed at the short-term rate, even if the underlying shares have been held for over a year. The guidelines regarding qualifications can be intricate, but the key is to ensure that the call is not lower by more than one strike price below the prior day's closing price , and the call has a time period of longer than 30 days until expiry.
For example, Taylor has held shares of MSFT since January of last year at $36 per share and decides to write the June 5 $45 call receiving a premium of $2.65. Because the closing price of the last trading day (May 22) was $46.90, one strike below would be $46.50, and since the expiry is less than 30 days away, their covered call is unqualified and the holding period of their shares will be suspended. If on June 5, the call is exercised and Taylor's shares are called away , Taylor will realize short-term capital gains, even though the holding period of their shares was over a year.
Protective puts are a little more straightforward, though barely just. If an investor has held shares of a stock for more than a year and wants to protect their position with a protective put, the investor will still be qualified for long-term capital gains. If the shares have been held for less than a year (say eleven months) and the investor purchases a protective put, even with more than a month of expiry left, the investor's holding period will immediately be negated and any gains upon sale of the stock will be short-term gains.
The same is true if shares of the underlying are purchased while holding the put option before the option's expiration date—regardless of how long the put has been held prior to the share purchase.
According to the IRS, losses of one security cannot be carried over towards the purchase of another "substantially identical" security within a 30-day time span. The wash sale rule applies to call options as well.
For example, if Taylor takes a loss on a stock, and buys the call option of that very same stock within thirty days, they will not be able to claim the loss. Instead, Taylor's loss will be added to the premium of the call option, and the holding period of the call will start from the date that they sold the shares.
Upon exercising their call, the cost basis of their new shares will include the call premium, as well as the carryover loss from the shares. The holding period of these new shares will begin upon the call exercise date.
Similarly, if Taylor were to take a loss on an option (call or put) and buy a similar option of the same stock, the loss from the first option would be disallowed, and the loss would be added to the premium of the second option.
Finally, we conclude with the tax treatment of straddles . Tax losses on straddles are only recognized to the extent that they offset the gains on the opposite position. If an investor were to enter a straddle position, and disposes of the call at a $500 loss but has unrealized gains of $300 on the puts, the investor will only be able to claim a $200 loss on the tax return for the current year.
Taxes on options are incredibly complex, but it is imperative that investors build a strong familiarity with the rules governing these derivative instruments. This article is by no means a thorough presentation of the nuances governing option tax treatments and should only serve as a prompt for further research. For an exhaustive list of tax nuances, please seek a tax professional.
Internal Revenue Service. " Topic No. 409 Capital Gains and Losses ."
Internal Revenue Service. " Publication 550: Investment Income and Expenses ."
Fidelity. " Tax implications of covered calls ."
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How to Report Stock Options on Your Tax Return
Written by a TurboTax Expert • Reviewed by a TurboTax CPA
Updated for Tax Year 2022 • December 1, 2022 08:24 AM
Stock options give you the right to buy shares of a particular stock at a specific price. The tricky part about reporting stock options on your taxes is that there are many different types of options, with varying tax implications.
Taxes on stock options
Receiving an employer stock option, exercising an option, selling stock, open market options, let a tax expert do your investment taxes for you.
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The underlying principle behind the taxation of stock options is that if you receive income, you will pay tax. Whether that income is considered a capital gain or ordinary income can affect how much tax you owe when you exercise your stock options.
There are two main types of stock options:
- Employer stock options
- Open market stock options
The two main types of stock options you might receive from your employer are:
- Incentive stock options (also known as statutory or qualified options, or ISOs) and
- Non-qualified stock options (aka non-statutory options or NSOs)
These employer stock options are often awarded at a discount or a fixed price to buy stock in the company. While both types of options are often used as bonus or reward payments to employees, they carry different tax implications.
The good news is that regardless of the type of option you are awarded, you usually won't face any tax consequences at the time you receive the option.
No matter how many statutory or non-statutory stock options you receive, you typically don't have to report them when you file your taxes until you exercise those options, unless the option is actively traded on an established market or its value can be readily determined. This exception is rare but does happen at times.
When you exercise an option, you agree to pay the price specified by the option for shares of stock, also called the award, strike, or exercise price.
For example, if you exercise the option to buy 100 shares of IBM stock at $150/share, at the time of exercise you'll effectively exchange your option for 100 shares of IBM stock, and you'll no longer have the right to buy additional IBM shares at $150/share.
- When you exercise an incentive stock option (ISO), there are generally no tax consequences, although you will have to use Form 6251 to determine if you owe any Alternative Minimum Tax (AMT) .
- However, when you exercise a non-statutory stock option (NSO), you're liable for ordinary income tax on the difference between the price you paid for the stock and the current fair market value.
If you exercise a non-statutory option for IBM at $150/share and the current market value is $160/share, you'll pay tax on the $10/share difference ($160 - $150 = $10).
For example:
- 100 shares x $150 (award price)/share = $15,000
- 100 shares x $160 (current market value)/share = $16,000
- $16,000 - $15,000 = $1,000 taxable income
Since you'll have to exercise your option through your employer, your employer will usually report the amount of your income on line 1 of your Form W-2 as ordinary wages or salary and the income will be included when you file your tax return.
When you sell stock you've acquired via the exercise of any type of option, you might face additional taxes.
- Just as if you bought a stock in the open market, if you acquire a stock by exercising an option and then sell it at a higher price, you have a taxable gain.
- If you satisfy the holding period requirement, by either keeping the stock for 1 year after exercising the option or 2 years after the grant date of the option, you will report a long-term capital gain , which is usually taxed at a lower rate.
- If you don't meet the holding period requirement, your gain is considered short-term and taxable as ordinary income.
You should report a long-term gain on Schedule D of Form 1040. A short-term gain will typically appear in box 1 of your W-2 as ordinary income, and you should file it as wages on Form 1040.
If you buy or sell a stock option in the open market, the taxation rules are similar to options you receive from an employer. When you buy an open-market option, you're not responsible for reporting any information on your tax return.
However, when you sell an option—or the stock you acquired by exercising the option—you must report the profit or loss on Schedule D of your Form 1040.
- If you've held the stock or option for one year or less, your sale will result in a short-term gain or loss, which will either add to or reduce your ordinary income.
- Options sold after a one year or longer holding period are considered long-term capital gains or losses.
Let a tax expert do your investment taxes for you, start to finish. With TurboTax Live Full Service Premier , our specialized tax experts are here to help with anything from stocks to crypto to rental income. Backed by our Full Service Guarantee . You can also file your own taxes with TurboTax Premier . Your investment tax situation, covered. File confidently with America’s #1 tax prep provider.
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Topic No. 427 Stock Options
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If you receive an option to buy stock as payment for your services, you may have income when you receive the option, when you exercise the option, or when you dispose of the option or stock received when you exercise the option. There are two types of stock options:
- Options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are statutory stock options .
- Stock options that are granted neither under an employee stock purchase plan nor an ISO plan are nonstatutory stock options .
Refer to Publication 525, Taxable and Nontaxable Income for assistance in determining whether you've been granted a statutory or a nonstatutory stock option.
Statutory Stock Options
If your employer grants you a statutory stock option, you generally don't include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO. For more information, refer to the Instructions for Form 6251 . You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income. Add these amounts, which are treated as wages, to the basis of the stock in determining the gain or loss on the stock's disposition. Refer to Publication 525 for specific details on the type of stock option, as well as rules for when income is reported and how income is reported for income tax purposes.
Incentive Stock Option - After exercising an ISO, you should receive from your employer a Form 3921, Exercise of an Incentive Stock Option Under Section 422(b) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income (if applicable) to be reported on your return.
Employee Stock Purchase Plan - After your first transfer or sale of stock acquired by exercising an option granted under an employee stock purchase plan, you should receive from your employer a Form 3922, Transfer of Stock Acquired Through an Employee Stock Purchase Plan under Section 423(c) . This form will report important dates and values needed to determine the correct amount of capital and ordinary income to be reported on your return.
Nonstatutory Stock Options
If your employer grants you a nonstatutory stock option, the amount of income to include and the time to include it depends on whether the fair market value of the option can be readily determined .
Readily Determined Fair Market Value - If an option is actively traded on an established market, you can readily determine the fair market value of the option. Refer to Publication 525 for other circumstances under which you can readily determine the fair market value of an option and the rules to determine when you should report income for an option with a readily determinable fair market value.
Not Readily Determined Fair Market Value - Most nonstatutory options don't have a readily determinable fair market value. For nonstatutory options without a readily determinable fair market value, there's no taxable event when the option is granted but you must include in income the fair market value of the stock received on exercise, less the amount paid, when you exercise the option. You have taxable income or deductible loss when you sell the stock you received by exercising the option. You generally treat this amount as a capital gain or loss. For specific information and reporting requirements, refer to Publication 525 .
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Stock Taxes
Tax implications of stock assignment vs. options, how to report the sale of stock call options.
The rule for stock options is that long positions can exercise but short positions can be assigned. The long position belongs to the option buyer, who has the right but not the obligation, to buy or sell 100 shares of an underlying stock at a set price -- the strike price -- on or before an expiration date. The Internal Revenue Service has special rules for taxing option assignments.
Non-Assignment OptionsTaxation
The short position belongs to the options writer. She can sell a put or call and collect a premium from the buyer. Her most profitable outcome is for the option to expire as worthless, because she books the entire premium as a short-term capital gain. She can also choose to offset her short position before expiration by buying an identical option: The two cancel each other and close out her position. The difference between her original premium and the price of the offsetting purchase is a short-term capital gain or loss. As in all option trades, she subtracts commissions from her proceeds to reduce her profit or increase her loss.
Short Call Assignment
When a buyer exercises a call, he purchases shares from a random call seller chosen by the Options Clearing Corporation. The seller receives the assignment notice and must fork over 100 shares of the underlying stock. She may have to buy the shares on the spot, but if she wrote a “covered” call she already has the shares in her portfolio. She figures her gain or loss by adding the original premium to the strike price and then subtracting her cost of the underlying shares. Her gain or loss is short-term unless she held the underlying shares for more than a year before selling the call, in which case it qualifies for long-term capital gains rates.
Short Put Assignment
A put owner can exercise his option before expiration. If the put writer is assigned, she will have to purchase 100 shares of the underlying stock at the strike price. In this case, she waits to pay tax on the premium she received when she sold the put until she eventually sells the 100 shares assigned to her. At that sale, she adds the original put premium to the share proceeds and subtracts the strike price. The capital gain or loss is long-term if she holds the assigned shares for more than a year before selling them.
2013 Capital Gains Rates
Your short-term capital gains rate is your marginal bracket -- the tax on your “last dollar” of annual income. The highest long-term capital gains rate is 20 percent, which applies to individuals with modified adjusted gross income exceeding $400,000 or couples filing jointly with more than $450,000 in MAGI. For those with less income, the rate is 15 percent for taxpayers in a 25 percent or higher bracket. For everyone else, the long-term gain is tax-free. You use capital losses to offset capital gains and up to $3,000 a year of ordinary income. You can carry over excess capital losses to future tax years.
2013 Medicare Surcharge
A Medicare 3.8 percent surcharge applies to individuals with MAGI exceeding $200,000 and couples with more than $250,000 in MAGI. The IRS applies the tax on the lesser of investment income and the amount by which MAGI exceeds the noted thresholds. Investment income includes capital gains unless they are shielded in an individual retirement arrangement.
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Taxes on Stock Option Premiums →
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- IRS: Publication 550 Investment Income and Expenses (Including Capital Gains and Losses)
- Oblivious Investor: Dividend and Long-Term Capital Gain Tax Rates for 2013
- This Matter: The Mechanics of Option Trading, Exercise, and Assignment
- Investor Place: What Is a Short Option Position?
- Optiontradingpedia: "Selling" Short Options Positions?
Based in Greenville SC, Eric Bank has been writing business-related articles since 1985. He holds an M.B.A. from New York University and an M.S. in finance from DePaul University. You can see samples of his work at ericbank.com.
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Trading Options: Understanding Assignment
The options market can seem to have a language of its own. To the average investor, there are likely a number of unfamiliar terms, but for an individual with a short options position—someone who has sold call or put options—there is perhaps no term more important than " assignment "—the fulfilling of the requirements of an options contract.
Options trading carries risk and requires specific approval from an investor's brokerage firm. For information about the inherent risks and characteristics of the options market, refer to the Characteristics and Risks of Standardized Options also known as the Options Disclosure Document (ODD).
When someone buys options to open a new position ("Buy to Open"), they are buying a right —either the right to buy the underlying security at a specified price (the strike price) in the case of a call option, or the right to sell the underlying security in the case of a put option.
On the flip side, when an individual sells, or writes, an option to open a new position ("Sell to Open"), they are accepting an obligation —either an obligation to sell the underlying security at the strike price in the case of a call option or the obligation to buy that security in the case of a put option. When an individual sells options to open a new position, they are said to be "short" those options. The seller does this in exchange for receiving the option's premium from the buyer.
Learn more about options from FINRA or access free courses like Options 101 at OCC Learning .
American-style options allow the buyer of a contract to exercise at any time during the life of the contract, whereas European-style options can be exercised only during a specified period just prior to expiration. For an investor selling American-style options, one of the risks is that the investor may be called upon at any time during the contract's term to fulfill its obligations. That is, as long as a short options position remains open, the seller may be subject to "assignment" on any day equity markets are open.
What is assignment?
An option assignment represents the seller's obligation to fulfill the terms of the contract by either selling or buying the underlying security at the exercise price. This obligation is triggered when the buyer of an option contract exercises their right to buy or sell the underlying security.
To ensure fairness in the distribution of American-style and European-style option assignments, the Options Clearing Corporation (OCC), which is the options industry clearing house, has an established process to randomly assign exercise notices to firms with an account that has a short option position. Once a firm receives an assignment, it then assigns this notice to one of its customers who has a short option contract of the same series. This short option contract is selected from a pool of such customers, either at random or by some other procedure specific to the brokerage firm.
How does an investor know if an option position will be assigned?
While an option seller will always have some level of uncertainty, being assigned may be a somewhat predictable event. Only about 7% of options positions are typically exercised, but that does not imply that investors can expect to be assigned on only 7% of their short positions. Investors may have some, all or none of their short positions assigned.
And while the majority of American-style options exercises (and assignments) happen on or near the contract's expiration, a long options holder can exercise their right at any time, even if the underlying security is halted for trading. Someone may exercise their options early based upon a significant price movement in the underlying security or if shares become difficult to borrow as the result of a pending corporate action such as a buyout or takeover.
Note: European-style options can only be exercised during a specified period just prior to expiration. In U.S. markets, the majority of options on commodity and index futures are European-style, while options on stocks and exchange-traded funds (ETF) are American-style. So, while SPDR S&P 500, or SPY options, which are options tied to an ETF that tracks the S&P 500, are American-style options, S&P 500 Index options, or SPX options, which are tied to S&P 500 futures contracts, are European-style options.
What happens after an option is assigned?
An investor who is assigned on a short option position is required to meet the terms of the written option contract upon receiving notification of the assignment. In the case of a short equity call, the seller of the option must deliver stock at the strike price and in return receives cash. An investor who doesn't already own the shares will need to acquire and deliver shares in return for cash in the amount of the strike price, multiplied by 100, since each contract represents 100 shares. In the case of a short equity put, the seller of the option is required to purchase the stock at the strike price.
How might an investor's account balance fluctuate after opening a short options position?
It is normal to see an account balance fluctuate after opening a short option position. Investors who have questions or concerns or who do not understand reported trade balances and assets valuations should contact their brokerage firm immediately for an explanation. Please keep in mind that short option positions can incur substantial risk in certain situations.
For example, say XYZ stock is trading at $40 and an investor sells 10 contracts for XYZ July 50 calls at $1.00, collecting a premium of $1,000, since each contract represents 100 shares ($1.00 premium x 10 contracts x 100 shares). Consider what happens if XYZ stock increases to $60, the call is exercised by the option holder and the investor is assigned. Should the investor not own the stock, they must now acquire and deliver 1,000 shares of XYZ at a price of $50 per share. Given the current stock price of $60, the investor's short stock position would result in an unrealized loss of $9,000 (a $10,000 loss from delivering shares $10 below current stock price minus the $1,000 premium collected earlier).
Note: Even if the investor's short call position had not been assigned, the investor's account balance in this example would still be negatively affected—at least until the options expire if they are not exercised. The investor's account position would be updated to reflect the investor's unrealized loss—what they could lose if an option is exercised (and they are assigned) at the current market price. This update does not represent an actual loss (or gain) until the option is actually exercised and the investor is assigned.
What happens if an investor opened a multi-leg strategy, but one leg is assigned?
American-style option holders have the right to exercise their options position prior to expiration regardless of whether the options are in-, at- or out-of-the-money. Investors can be assigned if any market participant holding calls or puts of the same series submits an exercise notice to their brokerage firm. When one leg is assigned, subsequent action may be required, which could include closing or adjusting the remaining position to avoid potential capital or margin implications resulting from the assignment. These actions may not be attractive and may result in a loss or a less-than-ideal gain.
If an investor's short option is assigned, the investor will be required to perform in accordance with their obligation to purchase or deliver the underlying security, regardless of the overall risk of their position when taking into account other options that may be owned as part of the overall multi-leg strategy. If the investor owns an option that serves to limit the risk of the overall spread position, it is up to the investor to exercise that option or to take other action to limit risk.
Below are a couple of examples that underscore how important it is for every investor to understand the risks associated with potential assignment during market hours and potentially adverse price movements in afterhours trading.
Example #1: An investor is short March 50 XYZ puts and long March 55 XYZ puts. At the close of business on March expiration, XYZ is priced at $56 per share, and both puts are out of the money, which means they have no intrinsic value. However, due to an unexpected news announcement shortly after the closing bell, the price of XYZ drops to $40 in after-hours trading. This could result in an assignment of the short March 50 puts, requiring the investor to purchase shares of XYZ at $50 per share. The investor would have needed to exercise the long March 55 puts in order to realize the gain on the initial multi-leg position. If the investor did not exercise the March 55 puts, those puts may expire and the investor may be exposed to the loss on the XYZ purchase at $50, a $10 per share loss with XYZ now trading at $40 per share, without receiving the benefit of selling XYZ at $55.
Example #2: An investor is short March 50 XYZ puts and long April 50 XYZ puts. At the close of business on March expiration, XYZ is priced at $45 per share, and the investor is assigned XYZ stock at $50. The investor will now own shares of XYZ at $50, along with the April 50 XYZ puts, which may be exercised at the investor's discretion. If the investor chooses not to exercise the April 50 puts, they will be required to pay for the shares that were assigned to them on the short March 50 XYZ puts until the April 50 puts are exercised or shares are otherwise disposed of.
Note: In either example, the short put position may be assigned prior to expiration at the discretion of the option holder. Investors can check with their brokerage firm regarding their option exercise procedures and cut-off times.
For options-specific questions, you may contact OCC's Investor Education team at [email protected] , via chat on OptionsEducation.org or subscribe to the OIC newsletter . If you have questions about options trading in your brokerage account, we encourage you to contact your brokerage firm. If after doing so you have not resolved the issue or have additional concerns, you can contact FINRA .
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How stock options are taxed
Bill bischoff.
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For individual investors out there dabbling in publicly traded stock options for the first time, you need to know how these securities get taxed.
For the uninitiated, lets start with some definitions. A put option gives the “holder” (the option owner) the right to sell a specified publicly traded stock at a set price (”strike price”) on or before a specified date. A call option, on the other hand, gives the holder the right to buy a security at a set price.
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Tax Treatment on Options Trading & Special Tax Treatment
Special tax treatments for options.
An essential component of being a good investor is understanding the taxes involved with buying and selling securities. Sometimes taxes can be as straightforward as paying the tax on capital gains and deducting losses from your taxable income. However, options can be a little more complicated.
Differences between stocks and options
Taxation of stocks is relatively simple. When you sell a stock at a gain, you will pay capital gains tax on it, and if you sell it at a loss then you can deduct it against your taxable income.
Due to the complex nature of options, there are many nuances to the tax rules that traders should familiarize themselves with to implement efficient financial plans and file their taxes correctly.
Short-term vs. long-term
Capital gains/losses are broken into two categories, long-term and short-term. Long-term tax rates are usually substantially lower than short-term capital gains tax rates.
The rule of thumb for long-term capital gains is that a security must be held for 365 days at least before the trader takes a profit or a loss on it.
Holding period
The length of time that a trader owns a security is referred to as the holding period. The holding period is used to determine whether a gain or loss is long or short-term. Under normal circumstances, the date that an option contract is purchased is the date used to start the holding period. There are a couple of exceptions that can change or offset the start date, such as trading covered calls and the Wash Sale Rule.
Covered calls
When a trader sells a call contract and simultaneously own shares of the stock that the contract represents, it is called a covered call.
Determining the tax for at-the-money and out-of-the-money covered calls depends on whether the call is unexercised, the call is exercised, or the call is bought back to close the position.
As an example, let’s say that Dave owns 100 shares of XYZ Corp, which is trading at $50, and he sells a $60 call for XYZ that expires in October at a $1.05 premium.
Option is not exercised
October rolls around, and XYZ is trading at $52. The call is not exercised, and Dave will net a short-term gain of $1.05 per share on the call he wrote.
Option is exercised
If the option is exercised, Dave will realize a capital gain on his shares of XYZ that is calculated off his total cost over the time he owned the shares. If he bought the shares last February at $40, his gain would be $21.05/share ($60 strike price – $38.95 price paid minus premium).
The option is bought to close
Dave decides to close his open call position by buying the contract back. The tax calculation is subject to what price he paid to purchase it back. If he spent less than he sold it for, he would record a capital gain, and if he paid more than he sold it for, he would record a loss.
In-the-money covered calls
The tax rules for covered calls that expire in the money are more complicated. They depend on whether the call is qualified or unqualified. Qualified covered calls can be taxed at long-term capital gains rates, while unqualified trades are taxed at short-term capital gains rates – regardless of how long the shares are held.
Determining whether a call is qualified or not is an intricate process, and more specific information can be found at the IRS website linked at the bottom of this page.
As a general rule, the call should not be lower than the previous day’s closing price, and it must have more than 30 days left until it expires.
Wash sale rule
The wash sale rule prevents losses in particular security from being transferred to a “substantially identical” security with a 30-day window.
If we look back at Dave, he could not take a loss on his XYZ stock, and immediately purchase a call option on XYZ within 30 days. The loss would not be allowed; rather, it would be added to the premium he paid for the new call option.
In this example, Dave’s holding period for the call option would start on the day he sold the shares of XYZ, not the day that he purchased the call.
Option expiration
When a trader purchases an option, either a call or a put, there is a stated expiration date unless the trader decides to roll it forward.
If the option expires at a profit, then the rules are similar to selling an option: if the option was held for less than a year, then it will be considered a short-term gain. If the option was held for more than a year, then it would be considered long-term.
It is important to note that if an option seller buys back the option to close out the position before it expires, then the resulting gain or loss is automatically treated as short-term. This rule applies even if the option was sold more than a year ago.
Option exercises and stock assignments
When an option is exercised , the trader does not report the position on Schedule D Form 8949. Instead, the option’s premium is either added or subtracted to the overall cost basis of the stock. The IRS applies different rules depending on whether it is a call or a put to determine how the premium is treated.
When a call is exercised, the holder purchases shares from the writer at the strike price. The holder adds the premium from the cost basis of the shares, and the writer includes the premium and increases the realized amount on the sale of the shares.
Let’s look at a hypothetical example:
Hannah purchased a call for ABC Inc. with a $100 strike price at a $2.00 premium that expires in six months. ABC is currently trading at $83. after Hannah purchases the option, ABC releases earnings and exceeds analyst predictions causing the stock to shoot to $112.
Since the option is now in-the-money, Hannah would like to exercise her option and purchase the shares of ABC. Her cost basis would be $10,200 ($100 strike price x 100 shares + $200 premium).
If she sells the shares three months later at $120, she will have realized a $20 gain per share ($120 market price – $100 strike price)
Since this trade was completed under a year, it would be considered a short-term capital gain, and Hannah would have to pay taxes accordingly.
Puts are treated similarly to calls, but if the option is exercised without the trader owning the shares, then the trade could be taxed under short-sale rules. These would calculate the total time starting at the exercise date to the closing date.
If a put is exercised, the holder reduces the amount realized from the sale of the shares by the price of the premium, and the writer reduces the cost basis of the stock received.
Benefits of exchange-traded/broad-based Indexed options
The IRS treats the sale of exchange-traded index options and other non-equity securities such as bonds or commodities, differently than other types of options transactions.
The 60/40 rule
In this case, the IRS rules can be quite favorable to traders due to the 60/40 rule. Under the 60/40 rule, 60% of gains are treated as long-term, and 40% are treated as short-term, regardless of the holding period.
Among the benefits of this rule are lower capital gains taxes. Since the holding period on the security does not influence the tax rate, the majority of capital gains from exchange-traded indexed options will be taxed at long-term rates, which have a maximum of 23.8%. Under the 60/40 rule, the short-term capital gains rate can reach as high as 43.4%, which enhances the benefit of the rule.
Other securities that fall under the 60/40 rule when held for less than a year include regulated futures and foreign currency contracts as well as non-equity, debt, commodity futures, and currency options.
At the end of the year, the IRS considers these contracts as marked to market (MTM) at their fair value. This MTM valuation treats them as if they were closed. Holding the securities longer will incur higher capital gains taxes.
As you can see, there is quite a bit of nuance when it comes to the tax treatment of options. While taxes are not fun, misfiling or misunderstanding, the tax implications of trades is much worse.
Fortunately, there is plenty of information on why options are taxed, and what rules are in place to assist traders.
By taking the time to research and understand the difference between short and long-term capital gains, how expiration can affect your taxes, and more, you will be in a much better position to plan out your trades.
For more information on special tax rules that apply when selling options, see IRS Publication 550 https://www.irs.gov/pub/irs-pdf/p550.pdf , page 60.
How are options taxed when exercised?
When an options contract is exercised, the IRS has specific rules about handling the cost basis of the new position. These rules differ depending on if a put or call option is exercised. The direction in which the cost basis is adjusted depends on whether the account holder is the buyer or seller and whether the contract is a call option or put option.
If the account holder is a buyer of a call option and chooses to exercise the option, add the cost of the call option to the cost basis of the stock purchased. For example, Sally buys a call option for $2 for ABC stock with a $50 strike price. If she exercises the option to buy ABC stock at $50, the cost basis in ABC is $50 + $2 = $52. The holding period for stock acquired when exercising an option begins the day after the option is exercised.
If the account owner is a buyer of a put option and chooses to exercise the option, subtract the put option’s cost from the amount realized on the exercise. For example, Bob buys a put option for $2 for ABC stock with a $50 strike price. If he exercises the option to sell ABC stock at $50, the amount realized on ABC’s sale is $50 - $2 = $48.
The IRS treats buying a put option as a short sale. The exercise, sale, or expiration of the put is a closing of the short sale. If the account holder has a long stock position and buys a put option, the holding period for capital gains or losses is dependent on how long the long stock position was held. For example, if Sue has held 100 shares of ABC stock for 6-months and buys and exercises a put option with a $50 strike, any gain on the exercise, sale, or expiration of the put is a short-term capital gain.
If the account owner sells a call or put, the premium received is a short-term capital gain. The account owner does not realize the gain until either the trade is closed or the option expires. If the put option sold is exercised and the owner is assigned stock, subtract the cost basis of the exercised stock by the amount of premium received. For example, Bob sells a put option on ABC stock for $2 with a $50 strike price. Bob is assigned ABC stock at $50. Bob’s cost basis in ABC stock is $50 - $2 = $48. His holding period in ABC stock begins on the date he was assigned and bought the stock, not the date he originally sold the put.
If a call option sold is exercised and the account owner is assigned stock, the amount realized on the sale of the stock is increased by the amount received in call option premium. For example, Sue sells a call option on ABC stock for $2 with a $50 strike price. The amount Sue realizes on the sale of the ABC stock position is $50 + $2 = $52. Her capital gain or loss is based on the $52 realized amount. The gain or loss on the ABC position is based on how long she holds ABC stock. If the holding period is longer than one year, the gain is considered long-term.
Unlike option sales and expirations, the option position is not reported on Schedule D Form 8949 when exercise or assignment happens. Instead, the proceeds from the sale of the option are included in the stock position from the assignment.
When calculating the tax liability, properly adjust the cost basis of stock to make sure the option premium is incorporated in the stock position’s cost basis.
How do I report options trading on my tax return?
Profits or losses from trading equity options are considered capital gains or losses (these get reported on IRS Schedule D, Form 8949).
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