Please contact customerservices lexology. This is a frequently asked question as many U. This post will provide a general summary of the tax consequences both to the recipient of an ISO or NSO and to the issuing company. Subject to certain exceptions as discussed below, an ISO is generally eligible for the following tax benefits: The employee is eligible for these advantageous tax consequences only if the employee does not dispose of the shares received pursuant to the exercise of the ISO within 2 years from the date of the granting of the ISO nor within 1 year after the ISO was exercised.
We note that in practice, ISOs are generally only granted by public companies where liquidity could be obtained by the recipient prior to a sale of the company and therefore the required share holding period of 1 year after exercise can be satisfied. In addition, the employee must exercise the ISO within three months after ceasing to be employed by the company or its subsidiary or parent or one year in the case of cessation of employment caused by permanent disability. Here is a summary describing this hypothetical, using the date of issuance as May 10, If the employee satisfies the holding period requirements, the company issuing the ISO receives no deduction at either the time of grant or exercise of the ISO.
In addition, based on the Internal Revenue Code the Code , the following requirements must be met in order to be properly considered an ISO:. If any of the above requirements are not satisfied, then the options are generally treated as nonqualified stock options, which are discussed in further detail below.
Unlike ISOs, NSOs can be issued to anyone, including employees, consultants, vendors, and members of the board of directors.
From a tax perspective, the recipient generally recognizes ordinary income upon exercise, equal to the excess of the fair market value of the stock at the date of exercise over the exercise price of the option. The company is required to withhold income and employment taxes at the time of exercise and will generally receive a tax deduction equal to the amount of ordinary income recognized by the recipient.
Depending on the terms of the grant, an NSO may also be subject to the penalty provisions in Section A of the Code for deferred compensation.