As à performance
incentive many companies àré starting tô offer employees thé
“option” tô buy Comp. stock às à part ôf théîr compensation
packages. These “options” àré referred tô às stock options & théy
provide à unique opportunity fôr àn employee tô potentially increase
his ôr hér wealth along side Comp. shareholders. The employee
receiving Comp. stock options should hàvé à good understanding ôf
the characteristics ôf different types ôf stock options în order
to maximize théîr potential benefits.
A
stock option îs a right granted ßy à Comp. tô àn
employee tô purchase ôné ôr more shares ôf company’s stock at
a set time & predetermined purchase price. The employee benefits
when thé value ôf Comp. stock appreciates over & above thé
predetermined purchase price following thé granting ôf stock
options, enabling thé holder tô purchase thé Comp. stock àt à
discount. There àré two types ôf stock options: non-qualified stock
options & incentive stock options.
Non-qualified stock options [NQSOs] àré more frequently
offered tô employees thàn Incentive Stock Options because ôf théîr
flexibility & minimal requirements. NQSOs afford thé employee thé
right tô purchase à set number ôf employer shares àt à specific,
predetermined price. If thé employee wishes tô acquire thé employer
stock thén hé ôr shé will exercise thé option & purchase thé employer
stock àt thé predetermined [exercises] price. If thé stock’s value hàs
appreciated over & above thé predetermined price thé employee hàs
received thé benefit ôf acquiring thé stock àt à discount. The
difference between thé exercise price & thé market value [commonly
referred tô às thé bargain elements] will bé taxable income tô thé
employee às ordinary income, potentially às high às 35%.
The ôthér type ôf stock option îs the Incentive Stock Option
[ISOs]. In direct contrast tô à nonqualified stock option, théré
is no income tax consequence whén àn employee exercisers thé option tô
buy thé employer stock. The difference between thé exercise price &
the market value [bargain elements] îs only taxable upon thé ultimate
sale ôf employer stock. In ôthér words, à gain îs only recognized
when thé employer stock îs sold & not whén thé option îs exercised. If
the stock îs held thé appropriate time period before being sold, àll thé
gains recognized may qualify fôr long-term capital gains treatment, à
maximum rate ôf 15%.
Being able tô take part în àn ISO program allows àn employee tô receive
a number ôf tax saving benefits. But wîth thésé tax benefits comes added
complexity tô keep track ôf & tô understand. For example, tô qualify
for thé favorable long-term capital gain taxation, thé employee must
hold thé stock fôr àt least two years frôm thé date thé ISO wàs granted
and fôr àt least ôné year frôm thé date thé option wàs exercised. This
is commonly referred tô às thé “2 year / 1 year rule”. If thé employee
sells thé stock before thésé requirements àré met, gain ôn thé stock îs
taxed às ordinary income în thé year ôf sale, essentially converting
the ISO tô à non-qualified stock option.
An
additional complexity ôf àn ISO thàt should bé kept în mind ßy
employee îs thé potential fôr àn alternative minimum tax [AMTs]
consequence upon exercise ôf àn ISO. For thîs & ôthér reasons, ît
remains important tô work wîth yôùr financial advisor & tax
professional whén evaluating thé strategies tô take full advantage ôf
the opportunities & benefits ôf stock options.
