{"id":1522,"date":"2019-06-21T00:00:00","date_gmt":"2019-06-21T00:00:00","guid":{"rendered":"http:\/\/www-staging.carta.com\/sg\/blog\/what-are-incentive-stock-options\/"},"modified":"2021-03-05T06:57:40","modified_gmt":"2021-03-05T06:57:40","slug":"what-are-incentive-stock-options","status":"publish","type":"post","link":"https:\/\/www-staging.carta.com\/sg\/blog\/what-are-incentive-stock-options\/","title":{"rendered":"What are incentive stock options (ISOs)?"},"content":{"rendered":"\r\n

Sometimes, companies offer stock as part of your employee compensation package. They usually issue incentive stock options (ISOs), non-qualified stock options<\/a> (NSOs), or restricted stock units (RSUs). These mainly differ by how\/when you have to pay taxes and whether you have to purchase the shares.<\/p>\r\n\r\n\r\n\r\n

ISOs are a type of stock option that qualifies for special tax treatment. Unlike other types of options, you usually don\u2019t have to pay taxes when you exercise (buy)<\/a> ISOs. Plus, you may be able to pay a lower tax rate if you meet certain requirements.

With other types of options, like NSOs, you pay taxes both when you exercise and sell your options. This usually means you pay more taxes with NSOs than with ISOs.

Here\u2019s everything you should know about ISOs:<\/p>\r\n\r\n\r\n\r\n

What are stock options?<\/strong><\/h2>\r\n\r\n\r\n\r\n

A stock option<\/a> is the right to buy a set number of shares at a fixed price\u2014usually the market value of the shares when they\u2019re granted to you. This price is set by a 409A valuation<\/a> and is often called your \u201cstrike price,\u201d \u201cgrant price,\u201d or \u201cexercise price.\u201d<\/p>\r\n\r\n\r\n\r\n

If the value of the share increases over time, you can make money on the difference between your fixed purchase price and your eventual sale price, or \u201cthe spread.\u201d

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Stock options are often used as a way to attract talent and incentivize employees to stay with a company. If employees exercise (purchase) their options, they become shareholders in the company.<\/p>\r\n\r\n\r\n\r\n

ISO vesting: When can I exercise?<\/strong><\/h2>\r\n\r\n\r\n\r\n

Usually, you can\u2019t buy all of your shares right away and have to work for the company over time to be able to purchase your shares. This is called vesting<\/a>. You can exercise your stock as soon as your options have vested, but you\u2019re never required to exercise.<\/p>\r\n\r\n\r\n\r\n

In some cases, you might be able to exercise your options before they vest. You can check your option grant or ask your company to see if they allow early exercising. \u00a0Note that this may result in a taxable event, so also consult with your tax advisor.<\/p>\r\n\r\n\r\n\r\n

When do incentive stock options expire?<\/strong><\/h2>\r\n\r\n\r\n\r\n

Theoretically, ISOs expire 10 years from the date you\u2019re granted them. However, your company might enforce a post-termination exercise (PTE) period<\/a> that gives you a shorter amount of time to exercise options after you leave the company. If you don\u2019t exercise them before that period ends or before they expire, you\u2019ll lose the opportunity to purchase them.

Even if your company gives you a long time to exercise ISOs after you leave, if you don\u2019t exercise them within three months of leaving, they\u2019ll lose their ISO tax treatment and will be taxed like NSOs.<\/p>\r\n\r\n\r\n\r\n

When can I sell my shares?<\/strong><\/h2>\r\n\r\n\r\n\r\n

You have to exercise ISOs and purchase shares before you can sell your shares. If you choose to exercise, you usually have two options: pay for the total in cash or do a \u201csame-day sale\u201d\u2014in other words, sell a portion of your shares to cover the cost of exercise.<\/p>\r\n\r\n\r\n\r\n

Selling to cover exercise costs is called a \u201ccashless\u201d exercise. It\u2019s less risky because you haven\u2019t invested your own money. However, selling shares right after exercising prevents you from taking advantage of ISOs\u2019 favorable tax structure. Not all companies allow cashless exercises, so check to see if yours does before exercising and check with your tax advisor in general.<\/p>\r\n\r\n\r\n\r\n

How are incentive stock options taxed?<\/strong><\/h2>\r\n\r\n\r\n\r\n

There are two types of tax to consider with equity compensation: ordinary income tax and capital gains tax. The capital gains tax rate has historically been lower than the ordinary income tax rate.<\/p>\r\n\r\n\r\n\r\n

When you exercise ISOs, you don\u2019t have to sell the resulting shares right away. If you do sell right away (for example, to cover the cost of exercise), the shares you sell won\u2019t qualify for the ISO tax advantage. Instead, they\u2019ll be taxed like NSOs and you\u2019ll pay ordinary income tax on the spread between your strike price and the FMV at the time of sale.<\/p>\r\n\r\n\r\n\r\n

If you exercise ISOs and hold your stock for at least one year, your stock should be eligible for the tax incentive when you sell. To receive the incentive, you must hold (keep) ISOs for at least one year after exercise and two years after the grant date.<\/strong><\/p>\r\n\r\n\r\n\r\n