If you meet the holding period requirements, your gain or loss on the sale of stock you buy by exercising your option is reported as a capital gain or loss on Schedule D.
But if you do not meet the holding requirements and you have a gain on the sale, part of the gain may be ordinary income. If you have a loss, it is a capital loss and you have no ordinary income.
Example
You receive an option to buy 100 shares of the company’s stock at $10 per share.
You later exercise the option when the stock’s market value is $12.
Within 2 years from the date you first received the option, you sell your 100 shares at $15 per share.
Your sales proceeds would be $1,500 (100 shares x $15 per share)
Your purchase price is $1,000 (100 shares x $10 option price per share)
Your gain would therefore be $500 ($1,500 proceeds minus $1,000 cost)
You would report $200 as ordinary income: fair market value of $1,200 ($12 x 100 shares) at the time of exercising the option, minus your option price of $1,000 ($10 x 100 shares)
The $300 balance of your gain would be reported as a capital gain
Employee Stock Purchase Plan – Options Granted at a Discount
If the option is granted at a price that is less than 100% (but not less than 85%) of the fair market value of the stock at the time the option is granted, and you dispose of the stock after meeting the holding period requirements, the amount of ordinary income you must report as employee compensation is the lesser of the following:
The excess of the fair market value of the share at the time the option was granted, over the option price paid for the share, or
The excess of the fair market value of the share at the time it was disposed of, over the option price paid for the share