Tax Benefits of Stock Options
As anyone who’s paid taxes knows, any sort of gain, whether it’s liquid assets or an intangible gain in asset value, will eventually be considered income by the IRS and taxed. Although the taxman eventually catches up with employees who receive stock options as payment, the tax rate on optioned income is delayed and frequently comes at a lesser rate than the one at which earned income is taxed, though the specifics rely upon the type of option your company provides.
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Incentive Stock Options
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The IRS treats shares earned in incentive stock options differently than earned income. Employees who exercise their stock options receive stock valued at an agreed upon portion of their payment. If you hold onto them for more than a year and it’s two years or more since you were offered the option, stocks acquired in this method aren’t taxed until you sell them.
When you do sell them, you’re taxed not on the entire value of the stock, but taxed on the difference between the value of the stock when you bought it and when you sold it. Unless your stock dramatically increases in value--which is hardly a financial hardship--the gains tax rate is usually more favorable than income tax you would have been required to pay on an equivalent amount of income.
Nonqualified Stock Options and Employees
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Nonqualified stock options aren’t as favorable toward employees, but still offer tax benefits. This income is taxed immediately when the employee exercises his stock options and is issued stock in the company. However, the tax rate only applies to the change in the stock’s value between the time the option was given and its price when the option was exercised. Thus, employees may receive compensation that’s taxed as income based only on its financial gains during the option period. Stocks acquired as part of an NSO and sold are subject to normal gains taxes.
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Nonqualified Stock Options and Corporations
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Nonqualified stock options aren’t treated as payroll by the IRS, and instead set themselves up to receive a tax deduction when employees exercise their stock options and claim their shares. Because of this, companies can transform compensation costs into future tax-year deductions.
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References
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