This is part three of a three-part series introducing different stock plans one should consider for their business. This is only meant to be an introduction; a trusted professional should be contacted to discuss what stock plan is right for your business. This third installment focuses on employee non-qualified stock option plans.
A stock option is a written offer from the employer to sell stock to an employee at a specified price within a specified time period. A non-qualified stock option (“NQSO”) is a stock option plan that gives the option-holder employee the right to purchase shares in the employer at the grant price (which is the fair market value of the shares as of the date of grant). As the employer grows in value, the value of the stock option rises. Options are generally restricted to a vesting period before they can be exercised to purchase shares. This requirement helps the employer retain key employees.
Generally, if the stock option does not have a readily ascertainable fair market value at the time the option is granted, it is not taxable income to the employee at the date of grant. Instead, the option is treated as taxable income when the employee purchases the option shares. The amount of taxable income is the difference between the fair market value of the shares at the date of purchase and the option price (the amount the employee pays for the shares). The employer does not receive a deduction when the option is granted but, instead, receives a deduction in the same year as the employee has taxable income as a result of exercising the option. The amount of the deduction is the same as the amount of the employee’s taxable income.