January, 2001 Hot Topics - part 1 of a 2-part series
Employee Stock Options - A Primer
Stock options give the option holder
the right to purchase a fixed number of shares in a company at a set price during a
specific time period. Stock options received
as compensation for services, whether as an employee or independent contractor, fall into
two categories for tax purposes: (i) incentive stock options or (ii) non-qualified
options. The main difference between these
two types of options is that once the option is exercised, the stock received under an
incentive stock option has the potential of being taxed at the more favorable long-term
capital gains rate, while stock received by exercising a non-qualified stock option is
taxed at ordinary income tax rates.
These stock options, however, have
numerous conditions and restrictions imposed by the company and by the Securities and
Exchange Commission (“SEC”) - the Agency with jurisdiction over the stock
market.
“Options” give you the right
to obtain a set number of shares of stock at fixed price (called the “strike
price”) during a fixed time period. This
is sometimes called a “call” option. A
“put” option gives you the right to sell stock at a certain price.
“Stock” means a stock
certificate that constitutes a right of ownership in a corporation. The owners of stock are called stockholders or
shareholders and they own 100% of the corporation. A
stockholder’s percentage ownership of a corporation is calculated by comparing the
number of shares owned by the stockholder to the total number of shares issued and
outstanding to all stockholders.
NOTE: The balance of this article has been incorporated into the Tax Prophet's Action Guide entitled, "Employee Stock Options - A Primer" described below:
This Action Guide is the product of the author's extensive experience in negotiating stock options as part of the compensation package paid to employees and contractors. In addition, the author represents several taxpayers who confronting huge tax bills stemming from the exercise of employee options and the subsequent crash of the stock market.
This Action Guide defines the key terms and concepts involving both incentive stock options (ISO's) and non-qualified stock options, identifies the tax-triggering events and discusses strategies to minimize the tax impact. The guide discusses the alternative minimum tax as applied to ISOs as well as sophisticated tax-planning concepts. This guide is a must read for employee or company that receives stock options as part of their compensation.
