Different types of incentive stock options

They are not - as many of us would like to have it - a way for employees to invest in their company. Indeed, this can be extremely dangerous. Here's a real example - many technology entrepreneurs got caught in exactly this situation. Just to be sure, I checked with the good folks at Deloitte and Touche and they confirmed that this situation can, and does, occur often!

Poor Jim! That doesn't help him because he has no other capital gains. He is bankrupt! So much for motivating him with incentive stock options!

Under the tax rules, the important point to remember is that a tax liability is assessed at the time when an option is exercised, not when the stock is actually sold. In the USA, the benefit is taxed as a capital gain if the shares are held for one year prior to sale! Let's go back to the example of Jill buying Multiactive stock. Up until recently, she would actually have to pay the tax in cash. Nice, eh?

Worried that she might have no profit, she sells. Not good. But true! She still gets no relief on her original tax bill. I wonder what happens if she never sells her shares? Would her tax liability be deferred forever? Again, this is OK. Because of the potential negative impact brought about by acquiring and holding shares, most employees are effectively forced into selling the shares immediately - i.

But, can you imagine the impact on a venture company's share price when five or six optionees "dump" hundreds of thousands of shares into the market?

About Stock Options

This does nothing to encourage employees to hold company shares. And it can mess up the market for a thinly traded security. From an investor's perspective, there's a huge downside to options, namely dilution. This is significant. From the company's perspective, the routine granting and subsequent exercising of options can quickly compound the outstanding share balance.

This gives rise to " market capitalization creep " - a steady rise in value of the company attributable to an increased stock float. Theoretically, share prices should fall slightly as new shares are issued. However, these new shares conveniently get absorbed, especially in hot markets.

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As an investor, is it easy to find out what a company's outstanding options are? No, it's not easy and the information isn't updated regularly. The quickest way is to check a company's most recent annual information circular available on www. You should also be able to find out how many options have been granted to insiders from the insider filing reports. However, it's tedious and not always reliable. The belief that options are better than company bonuses because the cash comes from the market, rather than from corporate cash flows, is nonsense.

The long term dilutive effect is far greater, not to mention the negative impact on earnings per share. Annual vesting will ensure that employees who get options do indeed add value.

1. The Basics of Incentive Stock Options – Daniel Zajac, CFP®;
2. An Introduction to Incentive Stock Options;
3. - EMPLOYEE STOCK OPTION PLANS.
4. Are Stock Options Right for Your Startup Company?;
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The term optionaire has been used to describe lucky option holders with highly appreciated options. When these optionaires become real millionaires, corporate managers must ask themselves if their payouts are really justified. Why should a secretary earn a half million dollar bonus just because she had 10, "token" options? What did she risk? And what about those instantly rich millionaire managers who decide to make a lifestyle change and quit their jobs?

Fidelity Investments – About Stock Options

Is this fair to investors? Stock option rules, regulations and the taxation issues that arise are very complex. There are also substantial differences in tax treatment between private companies and public companies. Once your options vest, you have the ability to exercise them.

This means you can actually buy shares of company stock.

Until you exercise, your options do not have any real value. The price that you will pay for those options is set in the contract that you signed when you started. You may hear people refer to this price as the grant price, strike price or exercise price. No matter how well or poorly the company does, this price will not change. You can also hold it and hope that the stock price will go up more. Note that you will also have to pay any commissions, fees and taxes that come with exercising and selling your options.

There are also some ways to exercise without having to put up the cash to buy all of your options. For example, you can make an exercise-and-sell transaction. To do this, you will purchase your options and immediately sell them. Rather than having to use your own money to exercise, the brokerage handling the sale will effectively front you the money, using the money made from the sale in order to cover what it costs you to buy the shares.

Compensation: Incentive Plans: Stock Options

Another way to exercise is through the exercise-and-sell-to-cover transaction. With this strategy, you sell just enough shares to cover your purchase of the shares, and hold the rest. You can find this in your contract. When and how you should exercise your stock options will depend on a number of factors. You would be better off buying on the market. But if the price is on the rise, you may want to wait on exercising your options. Once you exercise them, your money is sunk in those shares.

So why not wait until the market price is where you would sell? That said, if all indicators point to a climbing stock price and you can afford to hold your shares for at least a year, you may want to exercise your options now. Also, if your time period to exercise is about to expire, you may want to exercise your options to lock in your discounted price. You will usually need to pay taxes when you exercise or sell stock options.

What you pay will depend on what kind of options you have and how long you wait between exercising and selling.

With NQSOs, the federal government taxes them as regular income. The company granting you the stock will report your income on your W The amount of income reported will depend on the bargain element also called the compensation element. When you decide to sell your shares, you will have to pay taxes based on how long you held them. If you exercise options and then sell the shares within one year of the exercise date, you will report the transaction as a short-term capital gain.

This type of capital gain is subject to the regular federal income tax rates. If you sell your shares after one year of exercise, the sale falls under the category of long-term capital gains. The taxes on long-term capital gains are lower than the regular rates, which means you could save money on taxes by holding your shares for at least one year.