Q: What is a stock option?
A: A stock option is a right to purchase a certain number of shares of stock for a specific period of time, if certain conditions are met.
Q: What are the two types of stock options for tax purposes?
A: For tax purposes, there are two types of options: (i) incentive stock options (ISOs), and nonqualified stock options (NQOs).
ISOs are stock options that qualify for certain special tax benefits if certain conditions are met. NQOs are stock options that do not qualify as ISOs.
Q: Are stock options taxed differently from stock awards?
A: Yes, the differences in the tax treatment of stock options versus stock awards is dramatic. See What Type of Equity Incentive Should I Grant My Employees?
Q: Can a stock option be granted to an independent contractor?
A: Yes, but not an incentive stock option, only a nonqualified stock option. Only employees can receive Incentive Stock Options.
Q: Can a stock option be exercised with a nonrecourse note?
A: Yes, but the exercise of the option will likely be considered just the grant of an additional option until the note is paid down.
See this example from the Treasury Regulations:
Example 2. On November 17, 1972, W sells to E 100 shares of stock in W corporation with a fair market value of $10,000 in exchange for a $10,000 note without personal liability. The note requires E to make yearly payments of $2,000 commencing in 1973. E collects the dividends, votes the stock and pays the interest on the note. However, he makes no payments toward the face amount of the note. Because E has no personal liability on the note, and since E is making no payments towards the face amount of the note, the likelihood of E paying the full purchase price is in substantial doubt. As a result E has not incurred the risks of a beneficial owner that the value of the stock will decline. Therefore, no transfer of the stock has occurred on November 17, 1972, but an option to purchase the stock has been granted to E.
Q: If an employee issues a recourse note to his/her employer to pay the exercise price of a stock option, and the amount of that note is subsequently reduced by agreement of the employer and employee, does the employee recognize compensation income?
A: Yes, the employee would generally recognize compensation income under Section 83 of the IRC at the time of the reduction. See Revenue Ruling 2004-37. In addition, the compensation would be wages for purposes of FICA, FUTA and income tax withholding.
Q: Can stock options be granted to take into account service prior to the date the board awards the options?
A: Yes. Stock options can be granted partially or full vested.
Q: When does the capital gains holding period start with respect to an option?
A: The capital gains holding period does not start until the option is exercised.
Q: What is an immediately exercisable stock option?
A: An immediately exercisable stock option is a stock option that can be exercised by the holder upon grant, despite the fact that it is not vested. The shares received are subject to vesting by means of a share repurchase option held by the company, entitling the company to repurchase the shares purchased at the lower of FMV or cost if the holder’s service terminates before the holder satisfies the vesting conditions.
Incentive or Statutory Stock Options
Nonqualified or Nonstatutory Stock Options
Other Blog Posts I’ve Written on Stock Options