About Stock Option-ZT

Understanding Stock Options


Despite the controversy they have garnered lately, stock 


options are still fairly popular incentives for employees. 
 



Whether you work for a public or private company, you may reap


the benefits of these plans either today or in the future. We 


will focus on two types of stock options, non qualified stock 


options (NQSO) and incentive stock options (ISO) and how you 


could be taxed on these plans. 
 



First let's go over some terminology for stock options. 


* Grant date: The date you are given stock options. 


* Vesting Period: Dates you are eligible to exercise the stock


options. * Exercise price: Amount you pay to exercise your 


stock options. 
 



* Fair Market Value: current price of your stock. 


* Bargain element: The difference between the exercise price 


and the fair market value of the stock. For example you 


exercise your stock for $10 a share and the current price is


$20. Your bargain element is $10. 
 



* Alternative minimum tax (AMT): This is an extra tax some of 


you may have to pay above your regular income tax. The idea 


behind it is to prevent people with really high incomes from


paying little or no tax via special tax benefits or 


deductions. 
 



Non Qualified Stock Options (NQSO) 


Non qualified stock options are options that don't receive 


favorable tax treatment or deferrals. Your company does get a 


tax deduction on these plans and NQSO's are taxable at 


exercise. 
 



To illustrate the tax situation, let's use the example from 


above with the stock currently trading at $30. You exercise at


$10. You will pay ordinary tax on the $20 gain ($30 market 


value minus $10 exercise). Your cost basis is now $30. What if


the stock hits $50 a year later? Then you will owe long term 
 



capital gains tax on the subsequent $20 gain ($50-$30). 


Incentive Stock Option (ISO) 


This is also known as qualified stock options and is a tax 


favored plan. No taxes are due when you exercise ISO's. 


Typically only $100,000 worth of ISO's granted in one calendar
 



year gets favorable tax treatment. Anything above that gets 


treated as non qualified stock options. 


You have to be aware of the alternative minimum tax (AMT) on 


the bargain element at exercise. Suppose you were granted 


options and exercise them at $10 per share and the stock is 
 



valued at $30. The discount or bargain element equals $20. No 


taxes are due at this time. However the $20 bargain element 


could put you in AMT territory creating a higher tax bill for 


you. 


Remember you must hold the stock for two years after the grant
 



date and one year after your exercise date to get favored long


term capital gains treatment. If you sell the stock earlier, 


you will pay ordinary income tax on the bargain element ($20 


gain above the exercise in this case), and any ensuing gains 


since the exercise. Let's say the stock goes to $50 one year 
 



after the exercise at $10.00 and 2 years after the stock has 


been granted to you. The subsequent $40.00 gain will receive 


long term capital gains treatment. 


There is a lot more to discuss, especially on when you should 


exercise these options. We will discuss them in the coming 
 



weeks. For now know that the main difference between NQSO's 


and ISO's relates to their taxation. NQSO's are subject to 


regular income tax at exercise whereas ISO's are not. If you 


are in a high income bracket, you must pay attention to AMT 


when it comes to ISO's as it may apply to you in the year of 
 



exercise. These are difficult financial planning issues so 


please go to an advisor familiar with the ins and outs of 


these plans.