Lesson

Incentive stock options (ISOs) are a type of employee stock option that can provide certain tax advantages for both the employee and the employer. They are typically granted to employees as a form of compensation or as an incentive to stay with the company.

Practice Question #1

Which of the following is NOT a tax advantage of incentive stock options?

Options

Select an option above to see an explanation here.

Terms

Incentive Stock Option (ISO):
An employee stock option offering tax benefits for both the employee and employer.
Grant Date:
The date on which an employee is granted an ISO.
Exercise Price:
The price at which an employee can purchase shares of the company's stock through an ISO.
Vesting Period:
The period an employee must wait before they can exercise their ISOs.
Exercising:
Purchasing shares of a company's stock through an ISO.
Disqualifying Disposition:
A sale of shares acquired through an ISO before meeting certain holding period requirements, resulting in the loss of tax benefits.
Alternative Minimum Tax (AMT):
A supplemental income tax that may apply to individuals who exercise ISOs.
Bargain Element:
The difference between the exercise price of an ISO and the fair market value of the stock at the time of exercise.
Holding Period:
The required length of time an employee must hold shares acquired through an ISO to receive favorable tax treatment.

Practice Question #2

What is the required holding period for incentive stock options to receive favorable tax treatment?

Options

Select an option above to see an explanation here.

Do Not Confuse With

Non-Qualified Stock Option (NSO):
An employee stock option that does not offer the same tax benefits as an ISO.
Restricted Stock Units (RSUs):
A form of equity compensation that grants employees the right to receive shares of a company's stock after meeting certain vesting requirements.

Practice Question #3

Which of the following is a key difference between incentive stock options and non-qualified stock options?

Options

Select an option above to see an explanation here.

Historical Example

In the late 1990s, many technology companies used incentive stock options to attract and retain top talent. This led to a significant increase in employees who became millionaires due to exercising their ISOs and selling their shares at a substantial profit. However, the dot-com bubble burst in the early 2000s, causing many employees to lose a significant portion of their wealth.

Practice Question #4

Become a Pro Member to see more questions

Real-World Example

A software engineer is granted 1,000 incentive stock options with an exercise price of $10 per share. After the vesting period, the company's stock price has risen to $50 per share. The engineer exercises their ISOs, purchasing 1,000 shares for $10,000. If they hold the shares for the required holding period and then sell them, they will have a long-term capital gain of $40,000 ($50,000 sale proceeds - $10,000 exercise cost).

Practice Question #5

Become a Pro Member to see more questions

More Detail

- *Calculating Bargain Element*: The bargain element is the difference between the market price of the stock at the time of exercise and the exercise price of the stock option. - *ISO*: Incentive Stock Options (ISOs) are a type of employee stock option that provides favorable tax treatment for the employee. - *Alternative Minimum Tax (AMT)*: A parallel tax system designed to ensure that high-income individuals pay a minimum amount of tax, regardless of deductions and credits. - *Exercising ISOs*: The act of purchasing the underlying stock at the exercise price specified in the stock option agreement.

Practice Question #6

Become a Pro Member to see more questions

More Detail Examples

- *ISO example*: An employee is granted 1,000 ISOs with an exercise price of $10 per share. The stock price is $15 per share when the employee exercises the options. The bargain element is $5 ($15 - $10).

Practice Question #7

Become a Pro Member to see more questions

Pitfalls to Remember

- *Bargain Element pitfall*:
The bargain element is considered income for AMT purposes, even though it is not taxed as regular income. This can result in a higher tax liability for the employee.

Practice Question #8

Become a Pro Member to see more questions

Practice Question #9

Become a Pro Member to see more questions

Mark this subject as reviewed