Employee stock options can be a valuable source of wealth for some households, but it’s essential to grasp how they work before exercising them. Here are three must-knows about employee stock options.
When employees receive stock option grants, they have the opportunity to exercise them at a predetermined price (strike price or exercise price) at a later date. For example, Sharon received 100 shares of her employer stock in 2014 with a strike price of $10 per share and an expiration date of Dec. 31, 2023. If she exercised her options when the stock was trading at $20 per share, she would have profited from the difference between the exercise price ($1,000) and the shares’ value at exercise ($2,000).
However, the tax treatment of employee stock options varies depending on two key types: nonqualified stock options (NSOs) and incentive stock options (ISOs). NSO gains are taxed as ordinary income at the time of exercise, while ISO gains aren’t. To qualify for long-term capital gains rates on ISO profits, employees must hold the stock more than one year after exercise and two years beyond the grant date.
To mitigate company-specific risk, it’s crucial to diversify your shares and consider exercising options in stages rather than all at once. This helps spread out tax costs and avoids exercising at precisely the wrong time. Consulting with a tax or financial advisor who specializes in options can help you make informed decisions about your stock options.
By understanding how employee stock options work, employees can make more informed decisions about their wealth and achieve long-term financial goals.
Source: https://apnews.com/article/stock-options-compensation-morningstar-ef84dd0756c535c3614eac93a34fa5b0