Money Essentials

How to handle employee stock options

Empower yourself with vital information on how to handle employee stock options.

1. Employee stock options are no longer reserved for the executive suite.

From cash-poor Silicon Valley startups to old-line manufacturing and service firms competing for top talent, more and more companies are offering stock options to the rank and file as well.

2. Stock options are still popular.

According to the National Center for Employee Ownership, in 2010, of the publicly traded companies, 36% of employees own stock in their employers through one kind of plan or another.

3. Stock options can be expensive to exercise.

The lesson of the dot-com crash: Improperly exercising stock options can cause real financial headaches, particularly when it comes to paying taxes on your profits. Even if you keep the stock you purchased, you'll still have to pay taxes. But if you're careful not to overreach, options can be a lucrative benefit.

4. You'll see these common terms:

An employee stock option gives you the right to buy ("exercise") a certain number of shares of your employer's stock at a stated price (the "award," "strike," or "exercise" price) over a certain period of time (the "exercise" period).

5. There are two common types of plans:

Employee stock options come in two basic flavors: nonqualified stock options and qualified, or "incentive," stock options (ISOs). ISOs qualify for special tax treatment. For example, gains may be taxed at capital gains rates instead of higher, ordinary income rates. Incentive options go primarily to upper management, and employees usually get the nonqualified variety.

6. Nonqualified plans are special.

Unlike ISOs, nonqualified stock options can be granted at a discount to the stock's market value. They also are transferable to children and charity, provided your employer permits it.

7. There are three main ways to exercise options:

You can pay cash, swap employer stock you already own or borrow money from a stockbroker while simultaneously selling enough shares to cover your costs.

8. It's usually smart to hold options as long as you can.

Conventional wisdom holds that you should sit on your options until they are about to expire to allow the stock to appreciate and, therefore, maximize your gain. In the aftermath of the tech stock swoon, that logic may need some revision. In any event, you should not exercise options unless you have something better to do with the realized gain.

9. There may be compelling reasons to exercise early.

Among them: You have lost faith in your employer's prospects; you are overweighted on company stock and want to diversify for safety; you want to lock in a low-cost basis for nonqualified options; you want to avoid catapulting into a higher tax bracket by waiting.

10. Tax consequences can be tricky.

Unlike the case with nonqualified options, an ISO spread at exercise is considered a preference item for purposes of calculating the dreaded alternative minimum tax (AMT), increasing taxable income for AMT purposes.

take the test
the test
more lessons
More Money Essentials
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
More Galleries
What being middle class means to me For some Americans, middle class means feeling secure. For others, it's just the opposite. More
The 10 most valuable global brands Apple has the most valuable brand in the world, up 67% over the last year, according to a BrandZ ranking. More
A life's work: Photos by Mary Ellen Mark The subjects of Mary Ellen Mark's photography ranged from celebrities to world leaders to those at the fringe of society, including prostitutes and the homeless. More