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What Are Employee Stock Options?
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How Do Stock Options Work? A Guide for Employees - Smartasset
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By using the resources at your disposal, you can make a better decision with your stock options, and maximize their value while keeping taxes as low as possible. Investing Best Accounts. Stock Market Basics. Stock Market. Industries to Invest In. Getting Started.
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Planning for Retirement. Retired: What Now? Personal Finance. Credit Cards. About Us. Who Is the Motley Fool? Fool Podcasts. New Ventures. The hope is that the shares will be worth more in the future. Employees are incentivized by their paycheck, of course, but stock options can help supercharge that incentive in that they provide equity potential. With stock options, when the company does well, employees also benefit. They may also help with employee retention because they are usually awarded over a period of time. There are many different types of equity compensation, but the two types of stock options are non-qualified stock options and incentive stock options.
The biggest difference is whether the discount of the stock option the current market value less the strike price is treated as compensation to the employee. For a non-qualified stock option, the discount is considered to be compensation to the employee at the time of exercise.
Your individual circumstances will determine when the time is right
For the incentive stock option, that discount is generally not considered to be compensation. So the real benefit of the incentive stock options over non-qualified options is the potential to convert what would otherwise be treated as compensation into capital gains. Capital gains generally have a lower tax rate than compensation taxes. And it ultimately shifts all of the tax benefits and burdens over to the employee. However, once your firm becomes profitable, having the tax deduction on non-qualified options becomes much more valuable.
Get more k for less Learn More. So it allows an employer to potentially provide a lower salary in exchange for more potential equity upside. Compensation is usually a large part of that decision making process, especially for service-based companies. That frees up cash to hire other employees or invest in new products for the business.
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Even companies that are just starting out will want to do some kind of benchmarking to be sure they can attract the kind of talent they want and so may determine that stock options make sense. After that, I would say you would want to evaluate your equity compensation arrangements on an annual basis.