Incentive Stock Option
An Incentive Stock Option (ISO) tax structure is a stock purchase plan that is developed by a company to provide employees with tax advantages and/or “built-in discounts” regarding stock ownership. This sort of plan can provide individuals with substantial potential gains, but it does come with costs. The tax rules associated with the exercise and sale of stock can be extremely tricky for an ISO. To be clear about what an ISO actually is, consider the following structural components that are typical of ISOs:
- Schedule: A schedule determines the grant date, the exercise date, and the exercise window.
- Vesting: Vesting is the process by which individuals earn non-forfeitable rights to something, typically stock. This means that once you have worked at a company for a defined period of time, X, you will start to hold the value defined by the company in your offer. For example, imagine a company offered you 100 shares of stock as part of your compensation vesting over four years with a one-year cliff. This means that you will begin to accrue stock options after one year of employment (the vesting cliff), and that you will accrue an equal share of stocks over the remaining time, which is 25 shares for each year after the cliff (from above).
- Exercise Method: This defines how the options are exercised. ISOs typically have a number of ways that an employee can exercise their stock, like stock swaps, paying cash to exercise, or a cashless transaction as defined by relevant parties.
- Bargain Element: ISOs typically offer employees prices below market prices, which provides employees with immediate benefit.
- Clawback Provisions: Clawback provisions are the contractually defined principles by which a company can recall the granted options, like in the event of an employee for reasons other than death, disability, retirement, etc.
- Discrimination: ISOs aren’t necessarily offered to every employee at a company that uses ISOs as part of their compensation plans. Some companies only offer ISOs to executives and other key employees.
Incentive Stock Option (ISO) selection on Investopedia
Options Tax Calculator at Springmeyer Law
Joe Wallin's Incentive Stock Options vs. Nonqualified Stock Options at Startup Law Blog
Ian Artinger's NSOs Vs. ISOs – What’s the Difference? at Capshareblog
Tyler Hollenbeck's Understanding the differences between an ISO vs. NSO at The Venture Alley
Dave Naffziger's Startup Stock Options: ISOs vs. NSOs at Dave Naffziger's blog
Zibbie Nwokah's Equity 101 for Startup Employees (Part 3: Exercising and Taxes) at eShares