Incentive Stock Option Plans
Incentive stock options (ISOs) are a form of employee compensation that provides tax advantages to both the employer and the employee. They are generally granted to executives and other key personnel as an incentive to help the company succeed. ISOs are attractive because they offer the employee a chance to gain a financial benefit from the growth of the company in which they work.
A company typically grants ISOs in the form of a written or electronic agreement, or a stock option certificate. This document contains important terms and conditions, such as:
• Exercise Price : The exercise price is the price at which the option may be exercised by the employee. This is typically the market value of the stock at the time the option is granted.
• Expiration Date : ISOs expire on a certain date. This date is usually determined by the company’s board of directors, based on the terms of the stock option plan.
• Vesting Period : This is the period of time during which the employee must satisfy certain requirements before being able to exercise their options. The requirements can vary from company to company, but usually involve a combination of tenure with the company and performance-based criteria.
Normally, to exercise an ISO, the employee pays the exercise price and buys the shares at that price. The employee then owns the shares and can either keep them or sell them right away in the open market to realize the gain.
From a tax perspective, ISOs are often more advantageous than non-qualified stocks options (NSOs). With an ISO, the employee doesn’t have to pay income taxes on the gain until they sell the shares and the capital gains tax rate is usually lower than the ordinary income rate. In addition, because the gain is treated as a capital gain, the employee can use losses from other investments to offset the gains from the ISOs.
However, there are some drawbacks to exercise an ISO. To benefit from the favorable tax rate, the employee must satisfy the holding period rule, which requires that the option be exercised and the shares held for at least two years from the date of grant, and one year from the date of exercise. If these rules are not met, the gains from the ISOs are taxed as ordinary income.
Overall, ISOs are an attractive and effective way for companies to reward key employees and provide an incentive for them to work hard and help the company grow. The tax advantages for the employee and the company make these kinds of stock options an attractive option for both parties.
