Types of Employee Stock Options
Showing that you have confidence in your company by contributing funds to it can bring you considerable gains. Choosing whether to participate in an employee stock option plan involves considering how you want to pay and how long you plan to invest. Three options allow employees to tie their investment earnings to shareholder profit.
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Identification
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Stock option plans give an employee the right to purchase company stock within a specific time frame so they can earn money if the company does well in the stock market. Employee benefit from the opportunity to purchase stocks from a company they know and trust at an agreed price and then to sell at a higher market price. The important differences between options plans are in the plan structure and the tax treatment.
Types
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Employers offer three common types of options. Employee stock option plans that do not qualify for favorable tax treatment, called non-qualified options, give employees the chance to contribute their own funds to the company. These also are open to outside directors and consultants.
The remaining two types qualify for favorable tax treatment under Internal Revenue Code Sec. 421. Employee stock-purchase plans (EPPs) enable employees to turn their work earnings into company investments via a structured offer-and-purchase schedule, and incentive stock options (ISOs) pay certain employees, such as executives, for good performance.
Benefits
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As the business gains value in the market, the stock options earn money for the employees who have invested; these gains are realized when the employees sell or trade the stock after purchase. Non-qualified options offer the most choice for investing. You can purchase options any time you have available funds and an offer from the employer, and sell the stocks when you prefer.
EPPs have plan security and a discount price; the employer takes payroll deductions and pays on schedule until an option purchase date. The set price for purchase can be as low as 85 percent the market value. ISO investment earnings rise with performance.
Misconception
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Stock options are not a stock ownership plan. Unlike employee stock ownership plans (ESOPs), option plans offer the right to buy the stock. After paying for the option, the employee holds the right to buy until a planned purchase date in the future.
Tax
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Investment gains from plans that qualify under IRC Sec. 421 may be treated as capital gains instead of compensation income if you plan the option exercise and transfer at the right times.
For both EPPs and ISOs, the IRS allows you to claim the gain made upon sale or transfer--the difference between the agreed strike price and the stock price--as a capital gain. You benefit with a better tax rate when you hold onto an investment; options you buy at least one year from the grant date and transfer at least two years from this date qualify for the favorable tax treatment. Options bought or sold earlier are treated as income. The IRS treats non-qualified options gains as income regardless of when you buy and sell.
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- Photo Credit Image by Flickr.com, courtesy of David Orban
