Modern workers aren't just looking for a paycheck. They want to know what else a company has to offer. The right employee benefits can help companies stand out in a competitive hiring market and attract top talent. Modern benefits packages are looking well beyond basics like vision and dental or a 401(k).
Stock options are becoming an increasingly in-demand benefit, with a culture of "every employer an owner" gaining popularity. Employees benefit from the company's success, while the company benefits from more engaged employees who care about how the company performs.
That said, if you're thinking of incorporating stock options into your employee benefits package, it's important to do your research. The guide below explains what you need to know.
What is an employee stock option?
Employee stock options (ESOs) are a type of equity compensation, an important employee benefit. With ESOs, employees gain equity in the company—meaning they technically own a tiny part of it. ESOs work a bit differently than simply buying and selling stocks on the open market.
Instead of granting shares directly, most companies give their employees derivative options. These regular call options give workers the opportunity to buy company stock at a set price—usually discounted, compared to the open market value—within a certain timeframe.
When call options are announced, employees can exercise their option to buy stock. They can then decide to hold the stock, hoping it will grow more valuable over time, or sell it in the open market for an immediate profit.
The terms for ESOs vary. Usually, employees benefit if the company's stock becomes more valuable than the exercise price, which is the purchase price when the employee exercises their call option. This allows for a profit when reselling.
Here are a few of the most common types of ESOs, including how they work and how they’re taxed.
Incentive stock options
Incentive stock options (ISOs) are also referred to as qualified options or statutory options. They're usually offered to top management or core employees—for example, employees who were working for the company when it was first established.
The Internal Revenue Service (IRS) treats gains on ISOs as long-term capital gains. This can result in preferential tax treatment since capital gains tax rates are lower than normal income tax rates.
Non-qualified stock options
Non-qualified stock options (NSOs) may be granted to employees of all kinds and at all levels. They may even be awarded to consultants. Also called non-statutory stock options, NSOs are simpler and more common than ISOs.
In contrast to ISOs, NSOs are subject to a normal income tax rate instead of the capital gains tax rate. For context: The U.S. income tax rate ranges from 10% to 37% depending on the filer's income, while long-term capital gains have preferential tax rates of 0%, 15%, or 20% depending on income.
Restricted stock units
Restricted stock units (RSUs) award stock shares to an employee as a form of compensation. However, RSUs usually require certain conditions to be met before share ownership actually transfers to the employee.
For example, a vesting plan may be used for RSU distribution: Once the employee stays with the company for a predefined length of time—or achieves certain performance milestones—they gain ownership of the shares.
RSUs don't have value for the employee until they're vested. So, if the terms define that the employee must remain with the company for two years to be fully vested, they will want to stay for those two years—or else they lose the RSU value.
Once vested, RSUs are considered income and subject to standard income tax. A portion of the shares will usually be withheld to cover income taxes. The remaining shares then belong to the employee.
How are stock options taxed in the US?
Untangling the complexities of ESOs and how they're taxed can be tricky. Here's a quick recap:
- Incentive stock options (ISOs) are treated as long-term capital gains and are subject to capital gains taxes.
- Non-qualified stock options (NSOs) are subject to standard U.S. income tax rates.
- Restricted stock units (RSUs) are considered income after they're vested, at which point they're subject to income tax. A portion of the shares may be withheld to pay the relevant taxes.
How are stock options taxed internationally?
Keeping track of employee benefits across the world and the related admin around them can be tough. Oyster helps companies establish global benefits strategies that work, covering more than 180 countries. Find out more about Oyster.
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
Disclaimer: This blog and all information in it is provided for general informational purposes only. It does not, and is not intended to, constitute legal or tax advice. You should consult with a qualified legal or tax professional for advice regarding any legal or tax matter and prior to acting (or refraining from acting) on the basis of any information provided on this website.