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Incentive Stock Options vs. Non-Qualified Stock Options 

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US Individual income tax return. Accountant working with US tax forms

What type of stock to issue is one of the questions that executives of developing organizations face when issuing stock options. Stock options are classified into two types: non-qualified stock options (also known as non-statutory stock options) (NSOs) and incentive stock options (also referred to as statutory stock options). 

Both NSOs and ISOs grant the option holder the right to buy shares of stock at the stated exercise price if the underlying stock’s shares subject to the option improve in value, and it is typical for a stock option plan to allow both types of grants — but there are key differences. As a result, businesses and service providers must identify the differences between NSOs and ISOs. For more information, get the help of a Phoenix small business cpa today. 

Non-Qualified Stock Options and Incentive Stock Options 

Employees might benefit from stock options while also taking a risk. Employees are given restricted stock units but must purchase ISOs and NQOs. Exercising stock options at private corporations is riskier than at public companies. Employees may have fewer choices for recouping their investment in a private company because the company can limit when (or even if) shares can be sold. Before exercising your stock options, you should learn how they function and how your choice will affect your tax situation. 

After vesting, people can buy a specific amount of shares of the company’s stock at a predetermined price known as the strike or exercise price. Employees with stock options have the right but not the obligation to purchase shares. 

ISOs may qualify for preferential tax treatment. If a stock option is not an ISO, it is non-qualified. NQOs are not eligible for preferential tax treatment. The fundamental benefit of ISOs for employees is the favorable tax treatment, which includes long-term capital gains and no income recognition when they exercise their options. 

Employees can exercise their stock options and cash out in the typical exit via acquisition situation. Their stock options are converted directly to NQOs and do not benefit from special tax rates. 

In reality, there is no obvious difference between NSOs and ISOs. ISOs, however, may have an advantage in circumstances where employees should properly exercise and hold (for instance, the company goes public). 

The tax rules for option grants and exercises are complex and subject to change at any time. If you are a business considering option grants or someone eligible for grants, you should speak with your tax experts or attorneys before making a decision. 

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