Stock Option Incentives
Over 90 percent of the Fortune 1000 use stock options as one way of attracting, compensating and motivating employees. Not only can options greatly increase an employee's overall compensation, they cost the company relatively little and transfer the source of the employee's award to the public stock market.
Other People Are Reading
-
Function
-
As their name implies, incentive stock options are awarded to employees as part of a compensation package designed to attract the most highly skilled and qualified workers. Though they often cannot be liquidated immediately, they are generally expected to contribute to the employee's overall long-term compensation in addition to retirement plans and other benefits. In the meantime, they give the employee a stake in the company's well-being, incentivizing their success.
Features
-
Unlike public options that trade on the Chicago Board of Exchange, Incentive Stock Options confer special tax consideration and can only be awarded to employees. The date an ISO is given to an employee is called the grant date. This is important because the price of the stock on that date will be used to calculate any gains or losses when the shares are sold. The date the options are used to purchase actual shares is called the exercise date, which also determines the exercise price.
-
Effects
-
Section 422 of Internal Revenue Code gives preferential tax treatment to qualifying ISO income. First, the employee is not considered to receive any taxable income based upon the assignment of incentive options, and can only be taxed on the difference between the execution price and the final sale price of the shares. If, at the time, of sale more than two years have elapsed since the grant date and one year since the exercise date, then the profit, if any, is taxed as a long-term capital gain.
Identification
-
To qualify as a section 422 stock option, the company must first draft a plan that complies with the IRS regulations and is approved by shareholder vote. The plan must specify the total number of shares available under the plan and the types of employees eligible to receive such options.
Considerations
-
Ideally, the company's stock appreciates significantly at some point after the grant date. Since the award is for a specific number of shares, the total value of the incentive award will have also increased. The employee may avoid paying taxes on the stocks altogether if they are ultimately sold at or below the exercise price, even if this is considerably higher than the price of the shares on the grant date.
-
