Sale of employee stock options
Depending upon the tax treatment of stock options, they can be classified as either qualified stock options or non-qualified stock options. Qualified stock options are also called Incentive Stock Optionsor ISO. Gains from non-qualified stock options NQSO are considered ordinary income and are therefore not eligible for the tax break. NQSOs may have higher taxes, but they also afford a lot more flexibility in terms of whom they can be granted to and how they may be exercised. Companies typically prefer to grant non-qualified stock options because they can deduct the cost incurred for NQSOs as an operating expense sooner. More details about the differences, rules, and restrictions of qualified and non-qualified stock options are provided below along with example scenarios. Stock options are often used by a company to compensate current employees and to entice sale hires. Employee-type stock options but non-qualified can also be offered to non-employees, like suppliers, consultants, lawyers sale, and promoters, for services rendered. Stock options are call options on the common stock of a company, i. Employees hope to profit from exercising these options options the future when the stock price is higher. The date on which options stock awarded is called the grant date. The fair market value of the stock on the grant date is called the grant price. If this price is low, and if the value of the stock rises in the future, the recipient can exercise the option exercise her right to buy the stock at the grant price. This is where qualified and non-qualified stock options differ. With NQSOs, the recipient can immediately sell the stock she acquires by exercising the option. This is a "cashless exercise", because the recipient simply pockets the difference between sale market price and the grant price. She does not have to put up any cash of her own. But with qualified stock options, the recipient must acquire the shares and hold them for at least oneyear. This means paying cash to buy the stock at the grant price. It also means higher risk because the value of the stock may go down during the one-year holding period. The IRS and SEC have placed some restrictions on qualified stock options because of the favorable tax treatment they receive. Why do people use qualified stock options in spite of these restrictions? The reason is favorable tax treatment afforded to gains from QSOs. No taxes are due when qualified stock options are exercised and shares are purchased at the grant price even if the grant price is lower than options market value at the time of exercise. When non-qualified stock options are exercised, the gain is the difference between the market price FMV or fair market value on the date of exercise and the grant price. This gain is considered ordinary income and must be declared on the tax return for that year. Now if the recipient immediately sells the stock after exercising, there are no further tax considerations. However, if the recipient holds the shares after exercising the options, the FMV on the exercise date becomes the purchase price or "cost basis" of the shares. Now if the shares are held for another year, any further gains are considered long-term capital gains. If shares are sold before that timeframe, any further gains or losses are counted towards ordinary income. Now let's take a look at the different scenarios and calculate the tax implications. Scenario 1 is the classic qualified stock option. No income is declared when options are exercised and no taxes are due in Scenario 2 is an example of a disqualifying disposition even though the plan was a qualified stock option plan. The shares were not held for one year after exercise, so the tax benefits of a qualified ISO are not realized. Scenario 1 and Scenario options under the non-qualified category represent the same situation when the grant was under a non-qualified stock option plan. In Scenario 1, the shares are purchased and held for more than one year. In Scenario 2, shares are not held for more than one year. So the further gains are also considered ordinary income. Finally, scenario 3 is a special case of scenario 2 where the shares are sold immediately after they are acquired. This stock a "cashless exercise" of the stock options and the entire profit is considered ordinary income. If you read this far, you should follow us: Log in to edit comparisons or create employee comparisons in your area of expertise! Health Science Tech Home Food Business Insurance. Comparison chart Non-qualified Stock Options versus Qualified Stock Options options chart Non-qualified Stock Options Qualified Stock Options Recipient Can be issued to anyone, e. Options can be exercised at any time stock they vest. Must wait at least one year from the date QSOs are granted before exercising them. Exercise Price May have employee exercise price Exercise price must be at least equal to the fair market value FMV at time of options. Tax consequences recipient No tax at the time of grant. The recipient receives sale income or loss upon exercise, equal to the difference between the grant price and the FMV of the stock at date of exercise. No tax at the time of grant or at exercise. Capital gain or loss tax upon sale of stock if employee holds stock for at least 1 stock after exercising the option. Tax consequences company As long as the company fulfills withholding obligations, it can deduct the costs incurred as operating expense. This cost is equal to the ordinary income declared by the recipient. No deductions available to the company. Holding Period No restrictions Once options are exercised, the employee owns the stock. She must hold the stock for a minimum of one additional year before selling the shares. When the one year holding period has elapsed, the employee can sell the stock. Transferable May or may not be transferable Must be nontransferable, and exercisable no more than 10 years from grant. Qualified vs Non-qualified Stock Options 1 How Stock Options Work 2 Rules for Qualified Stock Options Incentive Stock Options 3 Tax Treatment 3. How Stock Options Work Stock options stock often used by a company to compensate current employees and to entice potential hires. The recipient must wait employee at least one year after the grant date before she can exercise the options. The recipient must wait for sale least one year after the exercise date before she can sell the stock. Only employees of the company can be recipients of qualified stock options issued by the company. Options expire after 10 years. Stock exercise price must equal or exceed the fair market value sale the underlying stock at the time of grant. Options are non-transferable except by will or by the laws of descent. The option cannot be exercised by anyone other than the option holder. To the extent it does, such options are treated as non-qualified stock options. Tax Treatment Options do people use qualified stock options in spite of these restrictions? Related Comparisons Audit vs Employee Audit Standard Employee vs Itemized Deduction Call Option vs Put Option Futures employee Options Limit Order vs Stop Order k vs IRA. Follow Share Cite Authors. Non-qualified Stock Options vs Qualified Stock Options. Audit vs Correspondence Audit Standard Deduction options Itemized Deduction Call Option vs Put Option Futures vs Options Limit Order vs Stop Order k vs IRA Debt vs Equity. Credit Cards vs Debit Cards CD vs Savings Account Copay vs Coinsurance HD vs HDX on Vudu Sushi vs Sashimi. Make Diffen Smarter Log in to edit comparisons or employee new comparisons in your area of expertise! Terms of use Privacy policy. Can sale issued to anyone, e. Exercise price must be at least equal to the fair market value FMV stock time of grant. No tax at the time of grant. As long as the company fulfills withholding obligations, it can deduct the costs incurred as operating expense. No limit on the value of stock that can be received as a result of exercise. Once options are exercised, the employee owns the stock. Must be nontransferable, and exercisable no more than 10 years from grant.
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