The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans.
A recent call with an advisor in Maryland is representative of a common inquiry involving 401(k) plans and stock options. The advisor asked:
“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’ W-2 forms for the year. Is this eligible/included as compensation for purposes of withholding salary deferrals?”
Highlights of Discussion
Whether income from the exercise of stock options is includable as W-2 income as defined in Treas. Reg. §1.415(c)-2(d)(4) 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 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:
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.
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The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.
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