Spread (Bargain Element)

What it means

When your company gives you the right to buy stock, they set a price you must pay, called the strike price. If the actual value of that stock (the fair market value) is higher than your strike price, you are buying it for a bargain. This difference between the real value and your price is the spread.

This spread is often viewed by the government as extra income you earned from your job. Because of this, you may owe taxes on that amount when you exercise your option, which is the act of buying the shares.

A simple example

Imagine Sarah has the right to buy 100 shares of her company's stock at a strike price of $5 per share. The company says the shares are now worth $15 each. Sarah decides to exercise her option. She pays $500 total. Because the shares are actually worth $1,500, her spread is $1,000 ($1,500 minus $500).

Why it matters to you

• If you have Non-Qualified Stock Options (NSOs), you will owe ordinary income tax on this spread immediately.
• If you have Incentive Stock Options (ISOs), the spread is used to calculate the Alternative Minimum Tax (AMT), which is a separate tax system meant to ensure everyone pays some tax.
• If you use early exercise to buy stock at the 409A valuation, the spread is zero because you are buying the stock for exactly what it is currently worth.
• A tax professional can help you understand how these rules apply to your specific situation.

Common mistakes to avoid

• Forgetting that you might owe tax on the spread even if you do not sell the stock right away.
• Thinking that the spread is always zero when you exercise your options.

Words used on this page

• Strike Price: The fixed price you pay to buy your company stock.
• Fair Market Value (FMV): The actual price a stock is worth on the open market today.
• Exercise: The act of purchasing the shares using your options.
• Ordinary Income: Money you earn from your job that is taxed at regular rates.
• Alternative Minimum Tax (AMT): A special tax calculation used to prevent people from using too many tax breaks.
• 409A Valuation: An official assessment of what a private company's stock is worth.