Stock options for employees, advisors, directors and other third parties offer employees attractive incentives and serve as an additional form of compensation for the staff working hard to make your company a success. Typically, these ISOs and NQOs confer special benefits that cost the company essentially nothing in the short-term—a fact that makes them especially appealing for startups and early-stage small businesses. Still deciding what kind of stock options to issue can be a real challenge for many companies, especially the first time it is done.
A top startup lawyer from the Priori network can help you not only set up the stock options with the correct paperwork, but also help you decide which choice is right. NQOs, short for non-qualified stock options, are the most common type of employee stock option. They allow you to purchase stock for a fixed price for a defined period of time, as the market value of the stock continues to rise, allowing employees to profit off the difference.
NQOs are just as they sound—unqualified.
Non-Qualified Stock Option (NSO) Definition
This means that they are not restricted by waiting periods, profit, price, employee status or any other stipulation. When employees sell shares after they vest, they have the potential to receive immediate, unlimited profit.
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ISOs, short for incentive stock options, are a type of employee stock option only offered to key employees and top-tier management that can confer preferential tax treatment. Unlike NQOs, they are subject to many restrictions.
Differences ISO vs. NSO
They must be held for a much longer time period, and thus can carry more risk; however, they have a higher potential for better returns. NQOs are unrestricted. As such, they can be offered to anyone. NQSOs can be granted to both non-employees, including non-employee directors, consultants and advisors, and employees. Employers can claim a tax deduction for NQSOs and are more straightforward to administer. One caveat is that income from an ISO is not treated as wages for employment tax purposes , while income from an NQSO plan is, requiring both employer and employee to pay employment taxes on NQSO plan payments.
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However, the NQSO tax deduction typically offsets this cost for the employer. Employers should consider their unique business needs and weigh the benefits of both types of plans before utilizing options as a form of compensation.
Incentive Stock Options (ISO)………..
Your firm simply grants the options at a fixed exercise price to a select group of employees. As the employees exercise the options, the company claims a tax deduction for the difference between the fair market value and the exercise price.
Of course, this amount is also taxable to the employees. For example, with an incentive stock option, the exercise price cannot be lower than the fair market value of the stock when the option is issued. There is no such restriction on nonqualified options. You may be surprised at the result.
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- ISO vs. NQSO Stock Options: Which is Right for Your Business? - Startup.