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Employee Stock Options
As you may well know, employee stock option is a benefit given by a corporation to their employees. Instead of giving them higher salaries, some corporations opt to provide their employees of the option to buy shares of stock of the company at a certain price within a specified time. There are two kinds of stock options that receive tax benefit from the government: the incentive stock options (ISO) and the employee stock purchase plan (ESPP). ISOs and ESPPs are given tax benefit under the Internal Revenue Code. ISOs and ESPPs are not recognized as income upon the grant of the stock option. It is only when the employee actually exercises the options and later on sells the stocks to another that tax responsibilities occur. Stock options have been increasingly popular these days in providing for long-term compensation for valuable employees. According to a survey conducted, nearly 90% of the Fortune 1000 companies offer some form of stock options.
Why Employee Stock Options?
You might be wondering why companies choose to provide their employees with stock options. One of the major reasons companies choose stock options is to be able to provide compensation for their employees without exhausting the cash flow by increasing salaries. Employee Stock Options is a way for the companies to hold on to their talented and hardworking employees as well as to attract more vibrant, equally talented recruits. Companies can also design their stock option plans to benefit only specific or 'key' employees by giving them better compensation than others. Providing for stock options is also ideal for companies that have little cash available but have promising growth potential.
From the employee's perspective, stock options provide for a more flexible agreement than in a retirement plan. Employees can feel that they are a part of the growth of the company as they will directly benefit once the stock prices of the company increases. Also, an employee loan program or the utilization of stocks may also be arranged by the company and the employee to enable the employee to exercise the stock option without shelling out too much cash. Unlike a qualified retirement plan, benefits and profits from stock options can be directly felt by the employee, even before retirement. Also, with the nature of stocks, capital gain opportunities are limitless.
Tax Obligations in ISO
Although there are tax benefits from ISOs, there are also certain tax obligations that have to be paid depending on the period of exercise of the tax option and the subsequent sale or disposition of the stocks. There is a statutory holding period for stocks that are obtained through ISO. They are one year from the time the ISO was exercised or two years from the time the ISO was conferred by the corporation. If you sell the stocks you obtained from the ISO within this period then that is called disqualifying disposition and the employee must face certain tax consequences.
The difference between the strike price or option exercise price and the share price at the time of the exercise of the option shall be considered ordinary income for tax purposes. Also, the amount gained from the stock price at the time of the exercise and the stock price at the time of disposition will be considered capital gains and shall be taxed accordingly.
In order to avoid these tax consequences one should only dispose of the stocks from ISO after the statutory holding period. By then, what you profited from the difference of the stock price at the time of exercise and the stock price at the time of disposition will only be taxed as capital gains. Capital gains taxes are substantially lower than ordinary income tax.
Why Employee Stock Options?
You might be wondering why companies choose to provide their employees with stock options. One of the major reasons companies choose stock options is to be able to provide compensation for their employees without exhausting the cash flow by increasing salaries. Employee Stock Options is a way for the companies to hold on to their talented and hardworking employees as well as to attract more vibrant, equally talented recruits. Companies can also design their stock option plans to benefit only specific or 'key' employees by giving them better compensation than others. Providing for stock options is also ideal for companies that have little cash available but have promising growth potential.
From the employee's perspective, stock options provide for a more flexible agreement than in a retirement plan. Employees can feel that they are a part of the growth of the company as they will directly benefit once the stock prices of the company increases. Also, an employee loan program or the utilization of stocks may also be arranged by the company and the employee to enable the employee to exercise the stock option without shelling out too much cash. Unlike a qualified retirement plan, benefits and profits from stock options can be directly felt by the employee, even before retirement. Also, with the nature of stocks, capital gain opportunities are limitless.
Tax Obligations in ISO
Although there are tax benefits from ISOs, there are also certain tax obligations that have to be paid depending on the period of exercise of the tax option and the subsequent sale or disposition of the stocks. There is a statutory holding period for stocks that are obtained through ISO. They are one year from the time the ISO was exercised or two years from the time the ISO was conferred by the corporation. If you sell the stocks you obtained from the ISO within this period then that is called disqualifying disposition and the employee must face certain tax consequences.
The difference between the strike price or option exercise price and the share price at the time of the exercise of the option shall be considered ordinary income for tax purposes. Also, the amount gained from the stock price at the time of the exercise and the stock price at the time of disposition will be considered capital gains and shall be taxed accordingly.
In order to avoid these tax consequences one should only dispose of the stocks from ISO after the statutory holding period. By then, what you profited from the difference of the stock price at the time of exercise and the stock price at the time of disposition will only be taxed as capital gains. Capital gains taxes are substantially lower than ordinary income tax.
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