“My client has participants in his company’s 401(k) plan who are receiving cash as a result of exercising their stock options. The client is going to report the income on the participants’ IRS Form W-2 for the year. Is this eligible/included as compensation for purposes of withholding salary deferrals? ”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.

Highlights of discussion

• Whether income from the exercise of stock options is includable as W-2 income as defined in 1.415(c)-2(d)(4) income for purposes of making salary deferrals to a 401(k) plan depends on whether the stock options are statutory or nonstatutory.
• W-2 income includes income from the exercise of nonstatutory stock options for the year the options are exercised.
• In contrast, income from the exercise of statutory stock options is excludable from W-2 income.
• Therefore, when a participant exercises nonstatutory stock options, he or she will have additional taxable income, reported on IRS Form W-2, which can increase the amount of money the individual has available for making 401(k) employee salary deferrals.
• The IRS has several publications with helpful information regarding the taxation of stock options: Topic 27, Publication 525, IRS CPE Compensation, Instructions Form W-2.

Conclusion

• Income from the exercise of nonstatutory stock options is included in W-2 income, and is eligible for deferral into a 401(k) plan up to the maximum annual limit.

© 2017 Retirement Learning Center, LLC, a subsidiary of Retirement Literacy Center