fairmark.com/execcomp/iso.htm
Roth IRAs |> 10 Custodial Accounts for Minors |> 11 Compensation in Stock and Options |> 12 Alternative Minimum Tax |> 13 Estimated Tax Payments |> 14 Tax Guide for Traders Fairmark Press |> 15 About Us |> 16 Fairmark News |> 17 Contact Us |> 18 Legal |> 19 Home 20 Compensation in Stock and Options Incentive Stock Options First page of our online guide to incentive stock options. Incentive stock options (ISOs) are a form of equity compensation that provides unique tax benefits -- and significant tax complexity. In recent years their popularity has grown to roughly match the popularity of nonqualified stock options. Nonqualified options have two disadvantages compared to incentive stock options. One is that you have to report taxable income at the time you exercise the option to buy stock, and the other is that the income is treated as compensation, which is taxed at higher rates than long-term capital gains. Incentive stock options provide a way to avoid both of those disadvantages. There's no income to report at the time you exercise the option (unless you sell the stock at the same time you buy it). And if you hold the stock long enough to satisfy a special holding period, your gain from the stock will be treated as long-term capital gain. These tax advantages are partly offset by the alternative minimum tax (AMT). This is a complicated calculation that may cause you to pay tax at the time you exercise an ISO. But the amount of AMT you pay is less than the tax you would have paid if you exercised a nonqualified option -- and you may be able to recover much or all of the your AMT payment by claiming an AMT credit in future years. How You Get Them Incentive stock options must be granted pursuant to a stock option plan that was adopted by the company's board of directors and approved by the shareholders. The board of directors, or a committee appointed by the board (usually called the compensation committee), may decide who receives the awards and the specific terms of the options. In some cases options are granted according to a formula. What You'll Receive When a company grants an option it should provide certain documents. You should receive an option agreement, setting forth the specific terms of your option, and a copy of the plan, which provides some general rules that govern all options. In many cases the company also provides a summary of the plan. It's important to understand your rights under the agreement and the plan. You need to know: * What is the earliest date you can exercise the option? Be sure to review them from time to time for planning purposes. At a minimum, you want to think about your options before the end of each year to determine whether to exercise some or all of the options by December 31 as part of your tax planning. Terminology Here are some of the important terms used in connection with nonqualified options: * You receive the option when the company makes a grant or award. Usually you have to fill out a form notifying the company that you are exercising the option and provide cash equal to the purchase price. For example, if the value of the stock is $24 and the exercise price is $19, the spread is $5. When the spread is a positive number, the option is in the money. There is no particular tax significance to an option being under water, but the practical significance is that the option will not become valuable until the price of the stock recovers. Typical Terms Companies have some flexibility in the terms they can offer for incentive stock options. Your option may differ from the typical option in a number of important ways. But it may be helpful to compare your option with the norm: * The exercise price is usually set at or near -- and can't be below -- the value of the stock at the time the option is granted. You may or may not have an opportunity to exercise options that are already vested (exercisable) at the time employment terminates. Options that are not exercisable at that time typically expire. Tax Rules for ISOs The following pages spell out the tax rules for incentive stock options: 21 ISOs Before Exercise Here are the main things to think about prior to the exercise of an incentive stock option. Shares sold in this manner are treated the same as shares from nonqualified options: you report compensation income but no AMT. Be sure to understand the unique tax consequences of this transaction. Sale of this stock may help you secure the benefit of the AMT credit.
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