As a form of compensation, some companies issue stock options to employees.
Nonqualified Stock Options (NSO) or Incentive Stock Options (ISO), is the
general form which these options take.
Nonqualified Stock Options are generally easier to establish and administer
and are generally less restrictive than Incentive Stock Options. Nonqualified
Stock Options can be granted to anyone, whether they are an employee or not,
unlike Incentive Stock Options. This can include non employee directors, and
outside consultants, etc. For preferential tax treatment, however Nonqualified
Stock Options do not satisfy the Internal Revenue Code's conditions.
When these options are granted, unless they are transferable options and they
have a fair market value on the Grant Date that can easily be determined, the
person receiving the options does not pay any income tax on them. They do
however pay ordinary income tax on the difference between the value of the stock
and the exercise price. The company, receives a tax deduction on the same
amount. A capital gain or loss will be incurred on the difference between what
the stock is sold for and the fair market value at the time of the exercise of
the option, when the stock obtained from the exercise is sold. The length of
time the shares were held after exercise, depends on the type of capital gain
(long term or short term).
