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What is a Qualifying Stock Option?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 10 October 2018
  • Copyright Protected:
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    Conjecture Corporation
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A qualifying stock option is a stock option provided to employees that meets the terms set by regulatory agencies to qualify for special treatment for tax purposes. Such options are less flexible than non-qualifying stock options, but come with tax benefits some employees feel are worth the hassle. They are also known as incentive stock options (ISOs) and it is important to read the terms and conditions carefully before exercising them to make sure they remain qualified for tax benefits.

When employees are offered a stock option, they are given a chance to buy stock in the company they work for at a set price, known as the exercise or strike price. A qualifying stock option is non-transferable and employees may need to wait a set period of time to exercise it. The stock holders have to approve the option offering and employees cannot receive options above a certain value. Once the waiting period is over, they can buy company stock at the exercise price, and then they usually need to wait again before reselling the stock.

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The exercise price of a qualifying stock option cannot be lower than the market price at the time the option is issued. In the event the company's stock declines in value and the exercise price is higher than the market price at the time employees are ready to exercise their stock options, the company may issue another offering at a lower price. This is designed to maintain the incentive aspect; there's no reason to exercise a stock option if people can get stocks more cheaply on the open market.

If a qualifying stock option is issued and handled properly, people qualify for some tax breaks on the income made from selling the stocks. This allows people to pocket more of the proceeds. For employees, stock options can be an appealing opportunity, providing a chance to invest in the company. Having stock options also creates an incentive to help the company do well, as employees will directly gain when the value of the company's stock rises.

When companies issue a qualifying stock option, they are careful to make sure they fall within the letter of the law, and employees can check with accountants and financial advisers to confirm their stocks are qualified. They should also discuss the timing of the exercise of the option to make sure they don't violate regulations. Exercising an option too soon or selling stock too early can expose people to the risk of having to pay higher taxes.

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