Some startups offer Incentive Stock Options (ISOs) in order to retain future hires. While ISOs can offer employees a stake of the company ownership,there are some tax implications you should know about. We’ll assist you with comprehension ISOs and fill you in on tax duties on your ISOs.
Incentive stock options, also known as statutory stock options. Some lucky employees get Incentive stock options from their startups. The employees can claim it as long as they are still working there. As a result, the employees can purchase them at a strike price in order to own the stocks.
What Is an Incentive Stock Option?
Employee, can get many different types of remunaretion , one of them is ISO. Incentive stock options can be used by employees as they are working for the company.
ISOs allow you to purchase shares of stock at a set price (the exercise price) for a set period. Nevertheless of the current market price. Equally important, If the current market price is higher than your exercise price, you are in the money. If the current market price is below the exercise price, your stock options are out of the money.
Incentive stock options may get you preferential tax treatment Paying less in tax.
Key Characteristics of ISOs
We provided for you all the critical information you will need to know. If you have incentive stock options you should know the following:
Clawback Provisions: Those are the small clauses or conditions that allow your employer to recall the options. As a result, the employee leaves the company or if the company itself becomes insolvent.
Bargain Element: ISOs are usually are exercise at market price. In some cases some, some executive employees are able to get their incentive stock options, at a price below the current market price.
Vesting: Is the period for an employee need to be able to exercise the options.ISOs The time period to be able to exercise. However, it varies it can be anything between 3 years to 5 years. Other employers use the graded vesting system.
Schedule: When it comes to schedules, you should be aware of the ISO issued date and the exercise date. Once the employee exercises his options, he has the total freedom to do sell or hold it.
Exercise Method: Isos are exercised in a few ways. The employee can pay for it to exercise them. Alternatively, you can use EquityBee. EquityBee helps startup employees get the money they need to exercise their stock options. Specifically, before they expire by connecting them to investors who provide them with the capital to do so.
ISOs Taxation rules
You need to report ISOs are for tax purposes at two different occasions , when exercised and when sold.
The first reporting with IRS occurs when you exercise your options. ISOs are an income when exercised solely for Alternative Minimum Tax(AMT). If you sell your ISOs you got, you need to report to AMT.
How they are taxed? When they are sold depends on whether the sale meets the criteria for a qualifying disposition or is considered disqualified.
How Are ISOs Taxed?
Tax Treatment for Qualifying Disposition
As a qualifying disposition, you enjoy a preferential tax treatment. To qualify, you need to sell the shares that you acquired at least 1 year after you exercised your ISO. Alternatively, at least 2 years after they were issued to you.
- In the following case, the profit from the sale of the ISO is a capital gain where the tax bracket is between 0%-20%.
Tax Treatment of a Disqualifying Disposition
If you don’t meet the qualifying disposition requirement, you are by default a Disqualifying Disposition and lose any tax advantages and you can’t be taxed under capital gain.
Disqualifying disposition pay taxes as below:
- The difference between Fair market value on exercise date and exercise price. You pay a tax as regular income. The tax bracket is between 10%-37%
- The difference between the Fair market value on the exercise date and the sale date. You pay a tax as a capital gain, the tax bracket is between 0%-20%
The capital gain tax rate varies. According if it is a long-term capital gain or a short-term capital gain. If you held them for at least a year, we meet the requirements for the more favourable long-term capital gains rates. For short-term, you pay as ordinary income when it is less than a year.
ISO’s are not so straight forward especially if you are classified as disqualifying disposition, we highlight recommend in consulting with your local financial advisor in order to the provider you a tailored answer based on your own circumstance.