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Stock Option Compensation and You

May 9, 2019

In one of our recent posts, we discussed the taxation of stock received as compensation by employees. In that post, we briefly discussed the difference between restricted stock and unrestricted stock. The general public doesn’t generally know about this distinction. The average person just assumes that “stock compensation” is the same across the board. But we know that this is far from the case. Stock grants are more than employee compensation for services. Stock is also an enticement for employees to stay with a company. Using stock to promote company loyalty is a sensible strategy. If you wish to retain certain employees, the best means to accomplish this is to align their interests with the company’s future. If an employee becomes a shareholder, it stands to reason that he or she will work harder to improve the company’s financial position.  

We also referenced the fact that stock options come in different forms. There are two kinds of stock options. The first kind are non-qualified stock options (NQSO). The second kind are incentive stock options (ISO). In this post, we will go over the differences between these 2 types of stock option compensation. We will also go over some of the terminology which employees may encounter if they receive stock options. As we’ll see, those who receive stock options may run into some esoteric terminology. Hopefully the definitions we provide can help demystify the situation. 

NQSOs vs. ISOs 

Non-qualified stock options and incentive stock options are quite different. Only employees can receive ISOs. Conversely, both employees and non-employees can receive NQSOs. Hence, whenever a non-employee contractor, consultant, director or other party receives stock option compensation, that person receives NQSOs.

As their moniker implies, ISOs promote employee retention. ISOs are issued according to a specified plan. That plan is approved by the company stockholders. The ISO plan must limit the number of option shares, and the grant price cannot be less than the current fair market value of the stock. The ISO plan must be implemented within 10 years of its approval by the stockholders. And, if granted, the ISO plan must be exercised within 10 years of the grant. If the ISO grants 10% or more of company stock, then the grant price must be at least 110% of the market price at the grant date. Also, if the ISO grants 10% or more of the company stock then the grantee must exercise within 5 years.

NQSOs are any options which fall outside of the rules established for ISOs. Hence, NQSOs do not require approval by the stockholders. NQSOs can issue to non-employees. There is also no required limit on the number of shares available. The grant price does not need to equal the current fair market value when the plan is granted. The taxation of ISOs and NQSOs are also a bit different, but we will dive into that topic in a future post. 

Common Stock Option Terminology 

Stock option compensation frequently brings with it a host of unfamiliar terminology to employees. Here are a few terms which a given stock option recipient may come across.  

Grant Price

The term “grant price” may also appear as the “exercise price” or “strike price” depending on the stock option plan. This the fixed price at which a recipient may elect to purchase stock from the plan. The benefit of stock options is that the grant price remains fixed even if the market price of the stock may fluctuate. So if you have a grant price of $20 and the share price rises to $50, you may have a very profitable situation.

Market Price

The market price is the current price of the stock as determined by the stock market. Again, the market price is likely to change during the time an employee owns the stock options. Employees need to be aware of the market price in order to take advantage of their options. 

Vesting Date

The vesting date is the date on which an employee gains the right to exercise the stock options. An employee may need to wait for a period before he or she can exercise the options. This technique is meant to retain the employee. 

Exercise Date

The exercise date is simply the date on which an employee actually purchases shares of stock from the plan. Purchasing is typically done through a brokerage firm. The employee contacts the brokerage firm and notifies them about the desire to utilize the stock options. 

Cashless Exercise

A cashless exercise refers to a transaction in which a stock sale occurs at the time of exercise. It covers the purchase price. Suppose an employee has the right to purchase stock at $50 per share, and the market price has risen to $100 per share. The employee wants to purchase 100 shares, but wishes to sell half to cover the purchase price. The brokerage firm sells 50 shares for $100 (for $5,000), and then uses that $5,000 to purchase the other 50 shares. The employee then receives these shares in a cashless transaction. 

Our New York City Tax Attorneys Can Help

Here at Mackay, Caswell & Callahan, P.C., we take pride in educating our readers in a wide variety of areas. The more educated our readership becomes, the better they will be able to optimize their financial future. Also, the better they will be able to identify when they need counsel to assist them. If you do receive stock option compensation, you will likely need to consult with a qualified tax professional at some point. If you ever run into tax issues associated with your compensation, please reach out to our New York City tax attorneys for immediate assistance. The tax attorneys at MCC can help resolve your issue and set your tax situation straight.

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