Learn more We often get asked about the difference between the two most common forms of equity grants — stock and options. This article is intended to highlight some of the important differences between them. The recipient becomes a stockholder in the company just like founders and other stockholders, has voting rights assuming he or she gets a form of stock that has voting rights and is otherwise a full-fledged stockholder.
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When a company issues stock to a service provider , the service provider recognizes taxable income equal to the fair market value of the stock received in excess of what he paid for it. Note, this assumes the advisor files an 83 b election. It is precisely this taxable income issue that leads many companies with valuable stock to issue….
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An option is a right to acquire stock. People holding options are not stockholders, do not vote like stockholders, and are merely holders of a contractual right to acquire stock. The tax law requirements around setting the exercise price for an option is complex and beyond the scope of this article, but the most common practice is to set the exercise price to be equal to the fair market value of a share of the type of stock that is issued if the option is exercised.
For example, if the option is for common stock, the exercise price would be the fair market value of a share of common stock on the date the option is granted which typically means the date the board approves the option. The idea with employee stock options is to give employees the ability or the possibility to purchase shares of the company's stock at a discounted price to market value. In theory, employee stock option awards are designed to not only encourage the employee to remain with the company through the end of the vesting period, but are also intended to be a motivational tool, as the employee will now directly benefit from the company's performance.
The future value of your employee stock options will depend on two factors: the performance of the underlying stock and the strike price of your options.
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With that in mind, here's a calculator that can help you determine the potential value of your stock options, based on hypothetical returns. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional. Of course, the actual value of your stock options depends on the actual performance of the stock during the time period prior to expiration.
However, based on expected rates of return, this calculator can help you determine the potential value of your options at expiration. The tax treatment of employee stock options depends on whether they're classified as non-qualified stock options NSOs or incentive stock options ISOs. With both types of options, the grant of the options is not a taxable event.
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The major difference is that with non-qualified stock options, taxation of the "bargain element" -- that is, the difference between the stock's market price and the exercise price -- begins at the time of exercise. Any further gain can be taxed when the shares are eventually sold. On the other hand, with incentive stock options, taxation doesn't occur until the shares are sold. In either case, if the shares are held for less than 12 months, any gain is considered a short-term gain and is taxable as ordinary income, while shares held for longer than 12 months are taxable at more favorable long-term capital gains rates.
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