Learn about stock option grants

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Many corporations issue stock option grants (An options contract given by a corporation to employees as part of a compensation package. The option grant allows the employee to purchase a certain number of shares of the corporation's capital stock at a strike price at or below the market price of the shares on the date of the option grant.) as part of compensation packages. You might be granted the option to purchase a certain number of shares of your companyÆs stock for a strike price (The price at which a stock can be purchased as defined within a stock option grant. For example, if an employee holds a stock option grant to by 10 shares of XYZ at a strike price of $50, the employee can purchase shares of XYZ for $50/share even if the stock has a market price of $100.) at or below the market price of the stock on a specific date. Then, you might need to work at the company for a specific period of time in order to vest (The right an employee acquires by length of service at a corporation to receive employer-contributed benefits such as stock option grants, employer contributions to a retirement plan, or profit-sharing plans.) the shares. Stock option grants generally have an expiration date (The date upon which the option to exercise shares vested in an employee stock option grant expires.) by which you must exercise (To make use of a right available in a contract. For example, if an employee holds a vested stock option grant, the right is exercised when the employee purchases the corporation's shares at the agreed-upon price designated in the contract (often referred to as the strike price.) the option to purchase the shares or else forfeit the option.

There are two major types of employee stock options:

Non-qualified stock options

Non-qualified stock options (NQSO) are option grants that corporations grant employees as a form of compensation. By far the most common form of stock option grant, NQSO let the employee purchase a certain number of shares at a stated price within a specified period of time. Gains realized on the exercise of these options are treated as ordinary income in the tax year in which the options are exercised.

Incentive stock options

Incentive stock options are usually reserved for executive-level employees of a corporation that permits the purchase of its capital stock. An employee holding incentive stock options pays no income tax either at the time of the stock grant or at the time the option is exercised. Profit on shares sold after being held two years or more after the date of the grant are subject to capital gains taxes. There is a $100,000 per employee limit on the value of stock covered by options that are exercisable in any one calendar year.

If I hold incentive stock options, how do I model the tax treatment for them?