What is the Incentive Stock Options (ISO)?
Incentive Stock Option (ISO) refers to the option which the company gives to its employees which allows them to purchase the stock of the company at a price which is lower than the prevailing market price. This technique is used by many companies to retain their top employees for the long run.
- There are two dates which we need to consider; the date on which such option is made available for exercising to the employees i.e. grant date; and the other is exercise date, the date on which the employee purchased the stock exercising the option given to them.
- The above option is given to employees for a particular period which has a maximum duration of three years i.e. if the option is made available for exercising on 01.04.2020 then it could maximum be open till 31.03.2023.
- The employees of the company could purchase the stock using cash or through a stock swap.
- The options given are also having some terms and conditions which are from the point of retaining the employees of the company for the company so that the skills of such employees are utilized by the company to the benefit of the company.
How does the Incentive Stock Options Works?
- The company gives an option to the existing employees of the company for purchasing a certain number of stock at a certain predetermined price after meeting the fixed eligibility criteria.
- If they are purchased by the employees then they need to behold by such employees for as per the vesting period.
- These types of options are generally given by the companies whose stocks are traded publicly or in other words say by public limited companies.
- This can sometimes be issued as a prerequisite to the employees for their continuous gratitude towards the organization.
When is Incentive Stock Options Taxed?
The stock options granted do not have the implication of taxes at the time of their allotment or at the time of exercising they are also taxed in the manner as other capital profits are taxed and at the same rate at which capital gains are taxed. The question and impact of taxability arise at the time of their sale by the stockholder. The fair market value of option exercised on the date of exercising the option will be subtracted from the sale value of a stock to compute the amount of capital gain earned and the amount of taxes to be paid thereupon.
- The government is going to get some amount as taxes from the persons who are selling such options after meeting the conditions laid upon at the time of exercising the option.
- These types of options help both the employer as well as employee as the employer gets surety of their employee retained and the employee will save some amount of money in the long run.
Advantages of Incentive Stock Options
- Under this method, the company is going to give its employees an opportunity to have ownership in the stock of the company in which they are working.
- It helps in creating long term savings for the employees of the company apart from their salaries which they have to spend on living their livelihood as well.
- Used as a saving strategy for employees of the company as It becomes very difficult to save from the salary which they regularly got.
- This also may result in far high capital appreciation to the employees which they could not achieve.
- There are no taxes till the sale of such stocks which they have purchased using such an option.
- It will affect the prevailing market price adversely as the existing stockholders who have purchased shares from the open market will tend to make negative makeup about the company.
- As the number of stockholders increases the financial position of the company got affected as EPS and Diluted EPS of the company will fall.
Incentive Stock Option is linked with retaining the employees of the companies as nowadays it becomes very difficult to the business to retain trustworthy and experienced employees so this is basically a method which is used by the companies whose workings are mainly dependent upon the employees of the company or by those companies which have the ideology of retaining experienced and such employees which are working for the company since long. The company gives them some sort of temptation for retaining them and enjoying their services for some more years.
This has been a guide to what is Incentive Stock Options and its definition. Here we discuss how does ISO works, its characteristics, along with advantages and disadvantages. You may learn more about financing from the following articles –