Case of the Week: Nonstatutory Stock Options and 401(k) Plan Deferrals

John Carl

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.

APEX 2017_winner 125x130 “Case of the Week” is the winner of an APEX Award for Publication Excellence for 2017.

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.

Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.

Columbia Threadneedle Investments (Columbia Threadneedle) is the global brand name of the Columbia and Threadneedle group of companies.

©2017, Columbia Management Investment Advisers, LLC. Used with permission.

Add Your Comments

One Comment

  1. Ken Prell
    Posted July 20, 2017 at 9:13 am | Permalink

    Your response failed to state the first course of action – refer to the definition of compensation in the plan document. Many (most) employers that are sophisticated enough to have stock options are also sophisticated enough to include the permissible exclusion from plan compensation of stock option income as well as income realized from the vesting of restricted stock.

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