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Incentive Stock Options (ISO)

Some companies issue stock options to some of their employees as a form of compensation. These generally come in the form of Incentive Stock Options (ISO), or Nonqualified Stock Options (NSO). ISOs must satisfy the conditions of the Internal Revenue Code for preferential tax treatment, so they are more restrictive than NSOs. For example, ISOs cannot be granted at a discount to the current stock price as NSOs can. Unlike NSOs, they can only be granted to employees. The exercise price cannot be lower than the fair market value of the stock on the grant date. They also cannot be transferred to another person, except through a will.

The employee pays no tax when the options are granted and no income tax when they are exercised. With these options, income tax for the employee is deferred until after the emplyee sells the stock obtained through exercise of the options. Capital gains are taxed as long term gains as long as the stock is held at least one year after exercise of the options and at least two years after they were granted. Otherwise the gain at exercise is taxed as ordinary income and the subsequent gain after exercise is taxed as short term capital gains. The gain at exercise is measured by the difference between the option exercise price and the stock value at the time of option exercise. If the ISO is exercised more than three months after the employee has left employment at the company which granted the options, favorable tax treatment is lost.

When an ISO is exercised and held, although there is no federal income tax at the time of exercise, the paper gain at exercise is subject to the alternative minimum tax (AMT), but this is merely a prepayment of tax, which will be credited back by the IRS at final disposition of the sale of the stock obtained when the option is exercised.

Employees can find the fair value of your options as well as make determinations about the best time to exercise your options or determine how much tax you will have to pay when you exercise your options at.

Employers can find the fair value of the options they grant to employees.

Related financial Sites:
Valuation of Company Options
Option Posting Service for Companies
Valuation of Employee Options
Forex Trading Resources

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