What Is an Incentive Stock Option?
Many companies use bonuses, incentives and other perks to attract and retain top-level talent. One way that companies try to accomplish this is with incentive stock options. Incentive stock options are issued according to a plan that is set up by the company as a way to reward employees.
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How it Works
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Companies issue incentive stock options to employees according to a schedule or based on performance. Employees who receive this option are given the right to buy a certain number of shares of stock at a specific price. When the price of the stock increases, the holder of the option could exercise the stock option and pay a lower price for the stock than what it is currently trading for on the market. The holder of the stock can then sell it for an immediate profit or keep it for the long-term.
Tax Advantages
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Incentive stock options are issued because of the relative tax advantages that they provide. With incentive stock options, you do not have to report any income at the time you exercise the option. With other types of options, this is when you have to report income. When dealing with incentive stock options, you only have to report income when you sell the stock. Another advantage of this type of option is that you only pay taxes at the capital gains tax rate, which is usually lower than what you would pay at income tax levels.
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Earning ISOs
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Employees may receive incentive stock options in a few different ways. Many companies use a specific schedule that gives certain employees a specific number of stock options for each year of service. This is a form of annual bonus that is given for being employed at the company. Another way that these stock options are given is in exchange for performance. For example, some companies give executives incentive stock options as bonuses once certain conditions are met.
Documentation
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If you are entitled to receive incentive stock options from your company, you should also receive some documentation that states it. In most cases you will receive an option agreement that outlines the information in the plan. In this option agreement you can learn about the rules such as when you can exercise the options. You could also learn exactly what you need to do when you want to exercise the option at some point in the future.
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