Stock options are a key part of the compensation of employees.
These are called Incentive Stock Options or ISOs.
If you exercise and sell the shares immediately, the proceeds will be taxed at the ordinary tax rates for the difference between the exercise price and the fair market value.
For ISOs, your options must qualify as an incentive option when it was granted and you must hold it long enough to be eligible for ISO tax treatment.
There are also non-qualified stock options for directors and stockholders.
The holder also pays the exercise price when sold and then pays taxes on the difference between the exercise price and the fair market value.
If you have 1000 options at an exercise price of $1 and the fair market value is $10, then you will pay the company $1000 to exercise the options and pay tax on the difference between the exercise price and the fair market value.
In this case, $9 per share or $9,000 in total.
If the shares continue to rise in value, then it may be prudent to sell the options sooner when the value is lower rather than later when the value has risen. You’ll pay less in taxes.
Also, remember that most options have an expiration date so you must keep track of it.
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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.