What are Qualified Stock Options?

Also known as incentive stock options or ISOs, qualified stock options are a particular class of employee stock options that are reserved for employees only. In some countries where this type of option is offered to employees, such as in the United States, there are usually some tax advantages that apply to the accrual of this type of stock each calendar year. Over the years, many corporations have used this method to allow employees to become investors in the company, and build a solid nest egg for retirement.

There are different models for determining how to go about issuing qualified stock options to employees. In some cases, the annual gross salary of the employee determines the number of shares. With this model, the company sets a limit on the number of shares that can be directed to a single employee each calendar year. Depending on the way the program is structured, the employee may pay a portion of the price of the shares via withholding from the paycheck, or the company may simply give the shares to the employee as part of the terms of the employee contract.

Regardless of how the qualified stock options are communicated to the employee, there is often a tax benefit that comes along with the shares. In many countries, including the United States, the employee does not have to pay taxes on the shares at the time they are issued. Even though the shares are held in an account under the employee’s name, and may be earning a return for the employee, there is no assessment of taxes until the employee actually takes control of those shares and receives some type of compensation from the account. The income from the shares is only taxable when the employee receives a dividend check after retirement, or when he or she chooses to sell those shares later in life.

In the event that the employee does not remain with the company all the way to retirement, there are often several options. If the employee is fully vested in the stock program, the qualified stock options simply remain in the control of the company until the former employee does reach retirement. In other situations, the shares are bought back by the company, with the former employee receiving the current market price for each share. Depending on the regulations in place in the country of jurisdiction, the employee may have the option of rolling the value of the shares into some other type of retirement program. This makes it unnecessary to pay taxes on the funds received from the shares until the funds are withdrawn at a later date.

Qualified stock options may function as the retirement program for employees, or simply be an added incentive that allows the employee to build a solid financial future. When this is the case, the options normally accompany some other type of retirement fund or pension plan. For the employee, this type of arrangement makes it possible to acquire company stock with relative ease, and build an asset for the future without having to spend a great deal of time or effort in the process.