Incentive Stock Options

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What is the Incentive Stock Options (ISO)?

Incentive Stock Option (ISO) refers to the option the company gives its employees. It allows them to purchase the company's stock at a lower price than the prevailing market price. Many companies use this technique to retain their top employees for the long run.

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Characteristics

  • There are two dates which we need to consider. One is the date on which such an option is made available to the employees, i.e., the grant date. And the other is the exercise date, the date on which the employee purchased the stock exercising the option given to them.
  • The above option given to employees is for a particular period, which has a maximum duration of three years. I.e., if the option is made available for exercising on 01.04.2020, then it could be open until 31.03.2023.
  • The company employees could purchase the stock using cash or through a stock swap.
  • The options given are with some terms and conditions from the point of retaining the employees for the company. The company does this to utilize the skills of such employees to benefit the company.
Incentive Stock Options

How do the Incentive Stock Options Works?

  • The company gives an option to the existing employees to purchase a certain number of stock at a specific predetermined price after meeting the fixed eligibility criteria.
  •  If the employees purchase them, they must be beheld by such employees as per the vesting period.
  • These options are generally given by the companies whose stocks are traded publicly or, in other words, by public limited companies.
  •  Companies sometimes issue these as a prerequisite for employees' continuous gratitude towards the organization.

When is Incentive Stock Options Taxed?

The stock options granted do not imply taxes at the time of their allotment or at the time of exercising. Taxation of these is in the manner of other capital profits and at the same tax rate as capital gains. The question and impact of taxability arise at the time of their sale by the stockholder. The fair market value of the option exercised on the date of exercising the option will be subtracted from the sale value of a stock to compute the capital gain earned and applicable taxes.

Importance

  • The government gets some taxes from the persons selling such options after meeting the conditions laid upon at the time of exercising the option.
  • These types of options help both the employer as well as the employee. The employer gets surety that their employee is retained, and the employee will save some money in the long run.

Advantages of Incentive Stock Options

  • Under this method, the company allows its employees to own the stock of the company in which they are working.
  • It helps create long-term savings for the company employees apart from their salaries, which they have to spend on living their livelihood as well.
  • Used as a saving strategy for employees of the company. It becomes challenging for employees to save from the salary which they regularly get;
  • It also may result in far high capital appreciation to the employees, which they could not achieve.
  • There are no taxes until the sale of such stocks they have purchased using such an option.

Disadvantages

  • It will affect the prevailing market price adversely. The existing stockholders who have purchased shares from the open market will tend to make negative makeup about the company.
  • As the number of stockholders increases, the financial position of the company got affected as EPS and Diluted EPS of the company will fall.

Conclusion

The Incentive Stock Option is linked with retaining the employees of the companies. Nowadays, it becomes tough for the business to retain trustworthy and experienced employees. So this is a method used by the companies whose workings are mainly dependent upon the employees of the company; or who have the ideology of retaining experienced employees working with the company for a long time. The company gives them some temptation to retain and enjoy their services for more years.