Tax treatment for stock options
Introduction
In today’s American businesses, it is common for companies to grant stock options to employees. Employees have the right to purchase the company’s stock at a given price over an extended period of time. Employee stock option is a kind of innovative compensation which benefits companies, stockholders, and employees. It helps match the interest of key employees with that of shareholders. In addition, it has been criticized that companies use this to compensate internal staff at the expense of ordinary stockholders, and treat it as tax avoidance devices. This paper is written to introduce the tax treatment of different types of stock options recorded in the Internal Revenue Code.
Definition
The stock option is a stock compensation plan to give key employees the option to purchase company’s common stock at a specified exercise price after a specified vesting period. The exercise price is the market price at the grant date. The vesting period is often the two or four years, and the option can be exercised in 5 or 10 years. The intrinsic value of the option occurs when the market value of company’s stock increase during the time until the option is exercised. Certainly, if the market price decrease in the exercisable period, the employee can choose not to exercise the option and buy the stock.
For the companies, the stock option has several advantages. Usually, the start-up companies use this method due to the lack of the immediate cash payment at the beginning. Actually, the stock option is a kind of promise to pay in the future, based on the increase of market value of the company’s stock. Moreover, the company provides opportunities to the employees to receive stock if performance of ...
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...income just like the salary. In addition, the income from later disposition of the stock would be recognized as capital gain. The amount is the spread between final stock selling price and fair value of stock at exercise date.
Conclusion
Incentive Stock Option and Nonqualified Stock Option have different tax treatment, but comparing to other compensation, the option compensation provide employees with the opportunity to convert ordinary, compensation income into capital gain. The current capital gain rate significantly takes the advantage for the employees. To take the benefits from stock option, people should clearly understand characteristics of different options and various tax treatment of them. In this way, the option recipients can wisely manage their stock options and carefully plan the time of the exercise of the stock and the later sale of the stock.
stock is overvalued. A case could be made to hold the stock if it is already
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There are a number of options to choose from, Employee Stock Ownership Plan (ESOP), Family limited
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