Incentive Stock Options give you the right, but not the obligation to purchase equity.
What is an Incentive Stock Option?
An Incentive Stock Option (ISO) is a type of employee stock option that offers certain tax advantages to the employee. ISOs are granted by a company to its employees as a form of compensation and are commonly used as a form of long-term incentive to align the interests of employees with those of the company.
How long do I have to hold the stock after exercising my ISOs?
You generally must hold the stock for at least two years from the date of grant and at least one year from the date of exercise before selling it in order to qualify for favorable tax treatment on the spread between the exercise price and the sale price.
What happens if I sell the stock before the holding period is met?
If you sell the stock before this holding period is met, it will be considered a "disqualifying disposition" and you will be subject to ordinary income tax on the spread at the time of exercise, as well as capital gains tax on any appreciation in the stock's value since the time of exercise.
What are the tax implications of ISOs?
The tax implications of ISOs can be favorable compared to other types of employee stock options, such as non-qualified stock options (NQSOs). With ISOs, you do not have to pay ordinary income tax on the spread between the exercise price and the fair market value of the stock at the time of exercise. Instead, you may be subject to capital gains tax when you sell the stock. However, if you sell the stock before the holding period is met, it will be a disqualifying disposition and you will be subject to ordinary income tax on the spread at the time of exercise, as well as capital gains tax on any appreciation in the stock's value since the time of exercise.
What is the "alternative minimum tax" (AMT) and how does it relate to ISOs?
The alternative minimum tax (AMT) is a separate tax calculation that is intended to ensure that taxpayers who have significant income from certain tax preference items, such as ISOs, pay at least a minimum amount of tax. It's a separate calculation that you do alongside your regular income tax calculation, and you pay the higher of the two. When you exercise ISOs, the spread between the exercise price and the fair market value of the stock is added to your AMT income for the year, which can increase your liability for the AMT.
What happens if my employer's stock price falls below the exercise price of my ISOs?
If the stock price falls below the exercise price, it means that the stock is underwater. In this case, the employee will not exercise the option, because the employee would be buying shares at a higher price than they can be sold. However, some companies may allow their employees to "cashless exercise" the option, meaning that they can sell the shares immediately after buying them at the exercise price, effectively avoiding the loss.
