Incentive Stock Options (ISOs)
Candlefocus EditorISOs have restrictions that make them different from other types of employee stock purchase plans. In order to qualify for favorable tax treatment, ISOs must have a vesting period of at least two years and a holding period of more than one year prior to sale. If these restrictions are not met, the employee may not be eligible for preferential treatment under the Internal Revenue Code.
The tax benefits of ISOs are attractive as they are often more favorable than other types of employee stock purchase plans. Specifically, when the employee exercises the option to purchase the company stock, he or she pays taxes on the difference between the limited offer price and the current fair market value of the stock (referred to as the spread). However, when the employee eventually sells the stock, any gains that have occurred since its purchase is taxed at the long-term capital gains rate, which is often lower than the marginal income tax rate.
Ultimately, ISOs are beneficial tools for employee compensation. They provide companies with the ability to retain key employees through the potential of long-term equity ownership, while also offering employees tax advantages on their stock profits. To understand the exact benefits associated with ISOs, both the employer and employee should speak with a tax adviser or other financial professional.