New York lawmakers recently passed tax hikes on the state’s highest earners, which could potentially carry tax implications for New Yorkers who decide to exercise their stock options in 2021.
- If you live or work in New York, you may have to pay income taxes when you exercise or sell your stock options.
- How much you’ll pay depends on the type of stock options you have (ISOs vs. NSOs), how long you hold your stock options before selling (short-term vs. long-term capital gains), whether and how much you experience gains when you sell, and whether you live in New York City or Yonkers (extra income taxes for people living in the Big Apple).
- Talk to your financial advisor or tax expert.
When New York lawmakers passed the state’s $212 billion budget in April 2021, the public latched onto the most eye-popping statistic: that ultra-wealthy earners living in New York City would pay the country’s highest combined state income tax rate of 14.776%, beating out California, which taxes its millionaires 13.3%.
And while most of us won’t have to worry about falling into that 14.776% state income tax bracket (earning more than $25 million in income in a single calendar year and living in New York City), the state did make changes to its income tax laws that could potentially affect New Yorkers who decide to exercise or sell their stock options this year.
People living in New York City and Yonkers pay an additional income tax of 3.078%, 3.762%, 3.819% or 3.876%, depending on their tax bracket, and regardless of their tax filing status:
- 3.078%: Income of less than $12,000
- 3.762%: Income of $12,001 to $25,000
- 3.819%: Income of $25,001 to $50,000
- 3.876%: Income of more than $50,000
Note that 2021 New York state income taxes were reduced by a fraction of a percent for two major middle-class tax brackets that many of the state’s residents find themselves in:
- Individuals earning between $21,401 and $215,400
- Married couples earning between $43,001 and $323,200
- Heads of households earning between $32,201 and $269,300
One last wrinkle: The state is applying a slightly different withholding rate on wages paid between Jan. 1, 2021 and July 1, 2021.
What does that mean for people who hold ISOs?
If you live or work in New York and you’re thinking about exercising or selling incentive stock options (ISOs), the state’s new tax brackets could potentially affect how much you owe Albany at the end of the year. Here are three common situations you might find yourself in if you hold ISOs:
I want to buy some ISOs this year:
I want to sell some ISOs that I’ve held for less than 1 year:
If you decide to sell ISOs that you’ve held for less than 1 year, you will have to pay New York state income taxes, on top of federal income taxes. ISOs are taxed as ordinary income if you sell them less than 2 years after your grant date and/or less than 1 year after you exercise them. How much you’ll owe in income taxes depends on the size of your gains, if any.
For example, let’s say you exercise 10,000 ISOs in January 2021 at a strike price of $1 per share, buying those shares for a total of $10,000. In October 2021, you sell those 10,000 shares to someone else for $5 per share, for a total of $50,000.
You’ve earned a gain of $40,000, which gets added as ordinary income on your state and federal taxes, alongside whatever you earn in wages, or other short-term investment income that year. Depending on how much you earn from your short-term ISO sale, you might find yourself bumped up into a higher state income tax bracket.
I want to sell some ISOs that I’ve held for more than 1 year:
If you decide to sell ISOs that you’ve held for more than 1 year, you’ll get long-term capital gains tax benefits on your federal tax return, but no such tax benefit on your New York state income tax return — New York taxes all gains from stock sales as ordinary income, no matter how long you hold the stock.
Depending on your unique personal finances, it may make sense to hold onto your ISOs for more than a year, to take advantage of long-term capital gains on your federal income taxes.
What does that mean for people who hold NSOs?
Non-qualified stock options (NSOs) are taxed differently from ISOs by the IRS and New York state. Your employer might only offer you NSOs, or you might find that your ISOs have automatically turned into NSOs if you (a) leave your company and fail to exercise your ISOs within 90 days and (b) work for a company that allows a more-than-90-day exercise window.
If you exercise or sell your NSOs in 2021, you may find that you owe income taxes to both the IRS and New York state. Here are three common situations you might find yourself in if you hold NSOs:
I want to buy NSOs this year:
One of the major differences between ISOs and NSOs is that you’ll likely owe taxes twice on NSOs: First, when you exercise them, and again, when it’s time to sell.
For example, let’s say you want to exercise 10,000 NSOs from your employer for $1 each, for a total cost of $10,000. The fair market value of those NSOs is $5 each — either set by a private company’s 409(a) valuation, or by the stock price if it’s a publicly traded company.
As soon as you exercise those NSOs, you’ll owe income taxes on the assumed gain, in this case, $40,000. If you live in New York, this gain is taxed as ordinary income by both the IRS and New York state.
I want to sell NSOs that I’ve held for less than 1 year:
Once you exercise your NSOs, you own your company’s stock and you get to decide when to sell. Some people end up buying and selling their NSOs on the same day, using the proceeds from the sale to cover the cost of the shares, effectively treating the one-day transaction like a cash bonus.
In that case, you’ll owe the ordinary income tax rate on the gain to both the IRS and New York state.
Other people exercise their NSOs and decide to hold onto them for some time to see if they’ll appreciate in value before selling. In that case, you’ll have to pay taxes again when you sell at a later date.
- In January 2021, you exercise 10,000 NSOs at $1 per share, spending a total of $10,000 to buy those shares.
- The day you purchased those shares, they had a fair market value of $5 per share, or $50,000. You’ll owe income taxes on the assumed gain (also known as the spread), or $40,000.
- In October 2021, you decide to sell your 10,000 shares. You’ve found a buyer who’s willing to buy your shares at $7 each, or $70,000 total. You’ll owe taxes on the additional gain — in this case, $20,000 — that you’ve realized.
If you sell NSOs less than 1 year after you exercise them, and/or less than 2 years after they were granted, the IRS and New York state will treat any gains you earn on the transaction as ordinary income, or short-term capital gains.
I want to sell NSOs that I’ve held for more than 1 year:
If you exercise NSOs and decide to hold onto them for more than 1 year before selling them, any gains you earn on that eventual sale will be taxed as long-term capital gains by the IRS. New York state treats all stock sales as ordinary income, no matter how long you hold onto the shares before selling.
Can exercising or selling stock bump me up into a new tax bracket?
One thing we occasionally hear in the wild is, “I’m on the edge of the next tax bracket, and I’m worried I’m going to lose money if I get a raise at work, or I sell some stock and it gets counted as income.”
Don’t worry, because the United States operates under a system of progressive taxation.
For example, let’s say you’re a single person living and working in New York City who earns a $200,000 annual salary, which falls into the combined New York income tax bracket of 10.2% (6.85% for New York state and 3.876% for New York City).
You decide to sell ISOs at a gains of $1 million, increasing your total income this year to $1.2 million, and bumping you up two tax brackets to 13.5% (9.65% for New York state and 3.876% for New York City).
Looking at those two numbers, you might think you’ll owe $162,000 in state income taxes. But no! Under progressive taxation, you’ll actually owe:
- $340 (4%) on the first $8,500 you earned
- $143.95 (4.5%) on the next $3,199 you earned
- $115.44 (5.25%) on the next $2,199 you earned
- $442.44 (5.9%) on the next $7,499 you earned
- $3,537.16 (5.97%) on the next $59,249 you earned
- $8,529.61 (6.33%) on the next $134,749 you earned
- $59,057.20 (6.85%) on the next $862,149 you earned
- $11,816.32 (9.65%) on the last $122,4549 you earned
- New York City $46,512 (3.876%) on the $1.2 million you earned
Add that all up, and you’ll owe a (hypothetical) total of $130,494.12 in combined state and New York City taxes in 2021, on $1.2 million in income.