When is a sale not final? In the world of stock options, sales can begin or end a transaction. Normally, you buy an option and then perhaps sell it at a later time. In Bizarro trading land, you can sell the option first and maybe buy it back later -- or maybe not. It all depends on the option’s price action. One thing is certain: The Internal Revenue Service wants to know everything about your option trading.
A call option gives the buyer the right to purchase 100 shares of the underlying stock for a given price -- the strike price -- on or before the expiration date. The call seller, or short position, collects a premium from the call buyer, or long position, and in return stands ready to deliver the 100 underlying shares at the strike price if the stock’s price is above the strike price on or before expiration. From the seller’s viewpoint, this original transaction is a “sell to open,” since it opens her position. If the buyer tires of his calls before they expire, he can enter a “sell to close” order, which cancels his option position.
The call buyer has three choices for disposing of his call option. He can let his option expire if it has no value, exercise the option to purchase the underlying stock, or simply sell the call to close his position. The long position may wish to sell his call for a number of reasons: locking in a profit, limiting a loss, or perhaps ending the call’s role as a hedge against other positions. He sells not his original option but an identical one -- the two options offset and cancel each other, ending the position. The buyer’s profit or loss is the call’s sale proceeds minus the premium he paid, adjusted for commissions. He reports the capital gain or loss on IRS Form 8949 for the tax year in which he sells the option or the option expires. Most option capital gains and losses are short-term. The long position would have to own the option for more than a year to qualify for long-term capital gains treatment of an offset.
The call seller, or “writer” collects a premium when establishing a short position through a sell-to-open transaction. The writer profits most if the call expires worthlessly. Her call premium minus commissions is her short-term capital gain. She reports this gain on Form 8949 as of the expiration date. She can also offset her short position by buying an identical call. She reports this short-term capital gain or loss as of the offset date. However, before offset and not later than expiration, the Options Clearing Corporation may “assign” the call writer the task of delivering the 100 underlying shares if their market price exceeds the call's strike price.
An assigned call writer must cough up 100 shares of the underlying stock. She might have the shares tucked away in her portfolio or may need to scarf up the shares in the open market. In either case, she has paid for the shares she must now deliver. The writer exchanges those shares for the strike price. At that point, the call writer subtracts the sum of the strike price and the call premium from the underlying stock purchase price to figure her gain or loss. If she purchased the stock at least a year and a day before assignment, she qualifies for long-term capital gains treatment. She reports her gain or loss on Form 8949 as of the assignment date.
In January, your broker will issue you and the IRS copies of Form 1099-B detailing all of your closed option trades for the previous year. You use these to complete Form 8949, Schedule D and Form 1040. In 2013, the short-term capital gains rate is your marginal tax bracket. The IRS taxes long-term capital gains at 20 percent, 15 percent or 0 percent, depending on your income. In addition, you may have to fork over a 3.8 percent Medicare surcharge if your modified adjusted gross income exceeds a threshold: $200,000 for individuals or $250,000 for joint filers. The surcharge applies to the lesser of investment income or the amount by which your modified adjusted gross income exceeds the noted thresholds.
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