Stock Options and Restricted Stock

If your business is incorporated, you can give or sell to employees (including owner-employees) the right to buy shares in the corporation. They can be a useful form of compensation when the business does not have cash on hand. Of course, when the options are exercised and employees obtain stock, this dilutes the ownership interests of previously existing shareholders.

There are 2 types of options: (1) qualified stock options, which are incentive stock options (ISOs) and options granted under an employee stock purchase plan (usually used only in large corporations and not discussed any further here), and (2) nonqualified employee stock options.

Incentive stock options (ISOs)
These are stock options meeting certain statutory requirements and that are granted to employees.
Employee stock purchase plan
This is a plan meeting statutory requirements to grant options to employees.
Nonqualified employee stock options
These are stock options granted to employees that do not meet statutory requirements.

ISOs. From the employee perspective, income is recognized not when the option is granted or exercised, but only when the stock acquired pursuant to the option is sold (provided certain holding periods are met). However, the exercise of an ISO may be an adjustment for purposes of the alternative minimum tax (see Chapter 28).

From the employer perspective, because employees do not have income from the ISO at the time it is granted or exercised, ...

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