Employee Stock Options

Typically your average employee will be willing to put in a sufficient amount of effort at work to keep the gears turning and ensure they will still have a job the next day. While the ideal scenario is that everyone under your employment is constantly striving to go above and beyond, this isn’t always the case. That is why many companies allow the option for their employees to invest in stock options. It used to be that stock options were offered to top management and particular key employees in order to tie their interests in with those of the company. However, recently employers are beginning to consider all of their employees to be key assets to the company, so the number of people holding stock options has increased significantly. 

What are They?

Essentially, employee stock options are contracts employers offer to employees to purchase a certain amount of shares of company stock at a fixed price. The employees that have been granted stock options they hope that the share price will go up and they will be able to “cash in” to make money. This gives them a vested interest in not only keeping the company afloat, but also increasing the net worth of the company, and thus increasing the amount in which they can cash in for. There are two classifications of stock options that are issued in this manner: non-qualified stock options (NSO) and incentive stock options (ISO). 


The main differences between an NSO and an ISO are the tax implications that come with each. ISO’s can only be offered to employees, whereas NSO’s can be offered to anyone. However, typically it’s better to have an ISO because it allows you to be more flexible in your tax strategy with them, thus lowering your tax burden. There is not a regular federal income tax that is recognized with the use of an ISO, while ordinary income is recognized with an NSO. This is based on the excess (if any) of the fair market value of the shares on the date of exercise over the exercise price. 

Tax Qualification Requirements

For ISOs, the option price must be equal or greater than the fair market value of the stock at the time of the grant. It cannot be transferable (except at death) and there is a $100,000 limit on the aggregate fair market value of stock that is acquired by an employee during any calendar year. This is determined at the time the option is granted, and any amount exceeding this limit is treated as an NSO. All options must be granted within ten years of plan adoption or approval of the plan (whichever is earlier) and must be exercised within ten years of grant. 

As for NSOs, there are no tax qualification requirements. However, an NSO granted with an option price less than the fair market value of the stock at the time of grant will be subject to taxation on vesting and penalty taxes under Section 409A.

Keep in mind the information provided above is not a fully comprehensive answer. We strongly advise that you consult a tax advisor before making any final decisions in regards to your company’s employee stock options.