Stock Options System
One of the ways a company keeps top level employees from leaving for other avenues is by offering stock options. Stock options can be a valuable incentive in retaining workers and can also be a means of attracting new talent and personnel.
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Definition
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Stocks options are private contracts that are entered into when a stockbroker agrees to sell someone the right to purchase "x" number of shares at a price that's been pre-set. The option has an expiration date, and if the date comes and the shares have not been bought, the option is worthless. Some companies offer employee stocks options, where the company allows employees to buy a certain number of stocks over the course of a specific number of years and at a specific price. Usually, the employee is only allowed to buy a percentage of the total number of stocks each year. So, the first year that an employee has stock options, he might only be allowed to buy 20 percent of the total number of stock options he possesses. Then, during the second year, he might be able to buy another 20 percent and so on. When stocks are bought during the option period, this is known as "exercising."
Incentive
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Incentive stock options are also known as "qualified" stock options because under the tax structure, they are "qualified" to get special treatment. With incentive stocks, taxes are not taken out upon exercising the option. Instead, taxes are held off until the stocks are sold. These options are usually only given to upper management personnel and to high-level brokers and traders.
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Non-qualified
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Non-qualified stock options are treated differently under the tax code. When the option is exercised, there must be taxes paid on the difference between how much the stock is valued at and how much it is worth at the time the option was exercised. For example, if an employee has a stock option of 100 shares at $50 a share, and he exercises that option at a time when the stock is selling publicly for $100 a share, under the tax law, that $5,000 difference is considered income and must be factored into income during tax filing.
Warning
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If an individual holds onto a stock in the hopes that it might go higher and it happens to crash, the Internal Revenue Service is still going to want taxes paid on the initial income figure. So, while holding onto the stock might have a potential increase in value, if the stock happens to drop rapidly and the individual sells it at a loss, the IRS still considers the value at the time of exercising the option to be income. In other words, if the stock was worth $5,000 at the time of the option and was sold when it was worthless, the IRS will count the $5,000 value of that stock as income, regardless of how the stock eventually turned out.
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References
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