Employee Stock Options

Within the past decade employee stock options (ESOs) have undergone significant changes both under law and in the way in which corporations issue them as part of an incentive program for employees. Where ESOs were once usually only offered to management, they are now commonly seen as part of a company-wide incentive package available to a greater number of employees. There are some interesting benefits to employee stock options if you understand the various types of ESOs and how you can use them to your advantage.

Three Main Types of ESOs
The type of ESO you receive as part of your compensation package will most likely be dependent on where you live. In the United States for instance, there are three main types of employee stock options which include Incentive Stock Options (ISOs), Non-Qualified Stock Options (NQSOs sometimes referred to as NSOs) and Put Options (Pos). While they are all handled a bit differently, the main difference is in terms of taxation.

Incentive Stock Options
ISOs can only be given to employees. This type of ESO provides tax benefits to the effect of when the option is exercised the stockholder/employee would not need to pay something called ordinary income tax or employment taxes. The employee would however be responsible for paying taxes due on the difference between the fair market valuation of shares when they were issued and the excise price. There is a possibility that the alternate minimum tax would need to be paid instead. Even though there are major tax benefits, this is a riskier type of option because they need to be held longer to qualify for the optimal tax benefits.

Non-Qualified Stock Options
Most employers prefer NSO/NQSOs because they are allowed to take a tax deduction when the employee exercises his or her right to the stocks. This deduction is equal then to the total amount the employee would be responsible for paying tax on which is the difference between the market value on that particular date and the exercise price. One thing to be aware of is that if the employee has taken deferred vesting then they must be in compliance with those rules enacted by Congress in 2004 in reference to tax deferred compensation.

Employee Put Options
As in any other Put, there is a contract between the issuer/employer and the buyer/employee. Put options work a bit differently in that the employee receives a short position which is the right to sell the stocks (upon exercising them) to the employer for the pre-agreed upon strike price. There will be taxable income at the point where the employee exercises his or her right to the stocks, even though they are being sold back to the employer as this will be considered taxable consideration.

ESOs Are Non-Transferable
There is one condition to stock options which is not viewed favorably by many employees and that is that ESOs are non-transferable. This means that employees cannot transfer the option/right to buy the stocks to a beneficiary or family member. Once purchased, the stocks however can be transferred as any equitable property could be. There comes a point close to being vested that the employee must determine whether or not to exercise his/her options because the stocks would then be transferable in the event of his or her untimely passing.

Statistics show that ESOs are being more frequently added to incentive packages for ordinary employees where they were once reserved for management. They need to be considered as part of the overall compensation package even though the amount that they are valued at may not be taxable. Learning when to exercise for the greatest tax advantages is important, but once you understand your particular type of ESO you can actually increase what your base salary would have been with smart financial planning.

Comments are closed.