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Incentive Stock Options: What Are They and Why Should I Want Them?

Incentive Stock Options: What Are They and Why Should I Want Them?

 

Photo Credit: AMagill

A form of equity compensations, incentive stock options provide unique tax benefits and complexity for employees and employers who are seeking smart stock options. But why are they so good, why should you want them and what do you do once you have one? Those questions are answered here.

Why are incentive stock options something to want? Why are they so great?

As opposed to non-qualified stock options, incentive stock options allow the avoidance of two hefty tax disadvantages. With non-qualified stock options, an employee is required to report all taxable income when their option is exercised and a stock is purchased. Additionally, that income is subject to tax at a rate that is much higher than that of any long term financial gains. These disadvantages have led many to seek incentive stock options for a multitude of reasons, one large one being the avoidance of these taxations.

Incentive stock options eliminate the need to tax in the way non-qualified options are taxed. With these stock options there is no income to report at the time of exercise. Furthermore, if the incentive stock options are held for an extended period of time, they could potentially earn long term capital gains if the predetermined holding period has expired.  However, if the shares are sold early, they are immediately taxed as ordinary income.

How do you go about getting incentive stock options?

Incentive stock options are usually included in a stock option plan that is traditionally adopted by a compensation committee or board of directors. How an employee qualifies is a dependent on the terms set forth by the board.

What do you get with your incentive stock option?

Besides the tax benefits and the obvious stock benefits, an employee will receive documentation of the stock options with all appropriate details of the option. Additionally, you will receive a stock option agreement; all of the stock option’s rules and regulations will be listed here. Be sure to pay attention to all of the details within this document so you can answer future questions as they present themselves.  Questions you will be able to answer could include the following:  When can I exercise? How do I exercise? How long are my stock options valid? Etc.

Incentive stock options are only one of the many facets associated with equity compensation plans; if you are anyone you know if looking to create an equity compensation plan of any kind, we encourage you to contact us today. Here at Stock Connections, we specialize in equity compensation plans and are prepared to answer any questions you may have regarding your own plan, incentive stock options and beyond.

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