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HighPeak Software - Employee Stock Options

Many people at many companies these days are receiving options as part of their pay package. The big issue and problem is that most people don't really have a clue about how they need to look at the value of the stock options. The only way to correctly view this is to understand the tax affects of employee stock options.

The first thing that you must understand is the Employee Stock Options are NOT the options that you can buy and sell in the open market. At best, you can either gift or transfer the options to a relative or to a trust.

There are two basic forms of stock options that companies can grant to employees; non-qualified stock options (NSO) and the incentive stock option (ISO). Non-qualified stock options are so named because they do not meet all of the requirements of the3 Internal Revenue Code (IRC) to be qualified as incentive stock options. The table below is a summary of the tax 'events' relating to the 2 kinds of stock options:

Date NSO ISO
Date of Grant No tax impact No tax impact
Date of Exercise Difference between fair market value of the stock and the exercise price is taxed as W2 income. Difference between the fair market value of stock and exercise cost is reported as a preference item for alternative minimum tax purposes on Form 6251.
Date of Sale Difference between fair market value of the stock and the basis is taxed as a capital gain. Basis is equal to exercise cost plus the amount recognized as ordinary income at the date of exercise. Difference between fair market value of the stock and the basis is taxed as capital gain; the basis is equal to the exercise cost at the date of exercise.

this table is 'lifted' from the AAII (American Association of Individual Investors) Journal - October, 1999.

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