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The Bottom Line Employee stock options can be a valuable part of your compensation package, especially if you work for a company whose stock has been soaring of late. In order to take full advantage, make sure you exercise your rights before they expire.
However, there are some downsides: Options being worthless if the stock value of the company doesnt grow. The possible dilution of other shareholders equity when option-holders exercise their stock options. Complex tax implications for ISOs, especially the concept of AMT.
Understanding Incentive Stock Options (ISOs) Options can be used to augment salaries or as a reward instead of a traditional salary raise. Stock options, like other benefits, can be used to attract talent, especially if the company cannot afford to pay competitive base salaries.
You Could Make a Lot of Money with Stock Options (But Theres No Guarantee) Think of a start-up company that gives you 100,000 company stock options with a strike price of $1 per share. At issue, they probably wont be worth much. Imagine though, that the price of the stock goes from $1 per share to $100 per share.
Stock options are a benefit often associated with startup companies, which may issue them in order to reward early employees when and if the company goes public. They are awarded by some fast-growing companies as an incentive for employees to work towards growing the value of the companys shares.
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If you choose to exercise your ISOs, you usually have two options: pay for the total in cash or do a same-day salein other words, sell a portion of your shares to cover the cost of exercise. Selling to cover exercise costs is called a cashless exercise. Its less risky because you havent invested your own money.
Heres an example: You can purchase 1,000 shares of company stock at $20 a share with your vested ISO. Shares are trading for $40 in the market. If you already own 500 company shares, you can swap those shares (500 shares x $40 market price = $20,000) for the 1,000 new shares, rather than paying $20,000 in cash.
You report the taxable income only when you sell the stock. And, depending on how long you own the stock, that income could be taxed at capital gain rates ranging from 0% to 23.8% (for sales in 2023)typically a lot lower than your regular income tax rate.

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