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Comparing Employee Stock Options
As you may have heard, employee stock options may either be Incentive Stock Options (ISO), Employee Stock Purchase Plans (ESPP) or Non-qualified Stock Options (NQSO). You may be wondering how ISOs, ESPPs and NQSOs are different. Why do employers give different kinds of employee stock options? What are the benefits of each? To help you understand more of the different kinds of employee stock options, I have prepared a short discussion of each.
Similarities
All three kinds of employee stock options function and operate in the same way. The employee is the holder of the option, the company is the writer, and the company's stocks are the underlying asset. They all offer what any call option offers, the choice of buying a specified number of shares of the company's stock at a strike price within a particular period.
Employee stock options, in general, are being continuously offered by companies to attract more talented and skillful employees as well as to retain their key employees or to augment compensation of their rank and file. Employee stock options also help the companies to provide more benefits to their employees without necessarily using up much of their cash flow.
Employee stock options are also advantageous to employees because they are able to benefit from their own hard work: the increase in growth and stock price of the company. Employees will have vested interest in bettering the corporation. Also, employees are able to realize the benefits of stock options even while they are still employed as compared to retirement plans. And unlike any added salary bonus which is fixed, the possibilities of earning in stocks are unlimited.
Also the ISO and ESPP are not taxable at the time of grant whereas NQSO can be taxed at the time of grant if the stock has ascertainable value. Neither is the ISO and ESPP taxable at the time of exercise. Furthermore, both the ISO and ESPP have tax benefits granted by the Internal Revenue Code. The ISO and ESPP also have the same statutory holding period: which is two years from the date of grant and one year from the date of exercise. Dispositions of stock within the holding period as well as outside the holding period produce the same tax effect on ISOs and ESPPs.
Differences
In order that an employee stock option is considered as an ISO, it must first meet the requirements set forth in Section 421(a) of the Internal Revenue Code.
Furthermore, ISOs are usually offered to key employees rather than the rank and file. Whereas an employee stock option becomes ESPP if it meets the requirements of Section 423 of the Internal Revenue Code. ESPPs are offered mostly to the rank and file.
NQSOs, on the other hand are employee stock options that do not meet any of the statutory requirements to be eligible for any tax benefit.
One of the major differences of ISO and ESPP is that the ISO must have a strike price equal to the share price at the time of grant whereas the ESPP can have 85% to 100% of the share price as strike price at the time of grant or exercise of the option.
NQSOs are preferred by some companies as they can be programmed for the specific needs of employees and even non-employees without worrying of restrictions. Furthermore, companies can set a very low option price in NQSO instead of being forced to set an option price in ISO and ESPP. NQSOs can also be effective for longer than 10 years as opposed to the mandatory 10 year exercise period in ISO and ESPP.
Similarities
All three kinds of employee stock options function and operate in the same way. The employee is the holder of the option, the company is the writer, and the company's stocks are the underlying asset. They all offer what any call option offers, the choice of buying a specified number of shares of the company's stock at a strike price within a particular period.
Employee stock options, in general, are being continuously offered by companies to attract more talented and skillful employees as well as to retain their key employees or to augment compensation of their rank and file. Employee stock options also help the companies to provide more benefits to their employees without necessarily using up much of their cash flow.
Employee stock options are also advantageous to employees because they are able to benefit from their own hard work: the increase in growth and stock price of the company. Employees will have vested interest in bettering the corporation. Also, employees are able to realize the benefits of stock options even while they are still employed as compared to retirement plans. And unlike any added salary bonus which is fixed, the possibilities of earning in stocks are unlimited.
Also the ISO and ESPP are not taxable at the time of grant whereas NQSO can be taxed at the time of grant if the stock has ascertainable value. Neither is the ISO and ESPP taxable at the time of exercise. Furthermore, both the ISO and ESPP have tax benefits granted by the Internal Revenue Code. The ISO and ESPP also have the same statutory holding period: which is two years from the date of grant and one year from the date of exercise. Dispositions of stock within the holding period as well as outside the holding period produce the same tax effect on ISOs and ESPPs.
Differences
In order that an employee stock option is considered as an ISO, it must first meet the requirements set forth in Section 421(a) of the Internal Revenue Code.
Furthermore, ISOs are usually offered to key employees rather than the rank and file. Whereas an employee stock option becomes ESPP if it meets the requirements of Section 423 of the Internal Revenue Code. ESPPs are offered mostly to the rank and file.
NQSOs, on the other hand are employee stock options that do not meet any of the statutory requirements to be eligible for any tax benefit.
One of the major differences of ISO and ESPP is that the ISO must have a strike price equal to the share price at the time of grant whereas the ESPP can have 85% to 100% of the share price as strike price at the time of grant or exercise of the option.
NQSOs are preferred by some companies as they can be programmed for the specific needs of employees and even non-employees without worrying of restrictions. Furthermore, companies can set a very low option price in NQSO instead of being forced to set an option price in ISO and ESPP. NQSOs can also be effective for longer than 10 years as opposed to the mandatory 10 year exercise period in ISO and ESPP.
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