Statutory stock options, also called incentive stock options, are specially regulated opportunities provided to certain employees of a company to buy stock in that company. In order to offer such options, a company must have a written plan that outlines how the program will work approved by the company’s board of directors and shareholders. Statutory stock options must also abide by certain rules regarding share price and time requirements on holding and exercising options. Benefits of these stock options usually include the potential to purchase stocks at a lower price and potential tax savings.
In general, statutory stock options are offered to employees as a type of deferred compensation. To set up this type of compensation plan, a company must create a document outlining the number of shares that will be offered to employees as statutory stock options, the price at which shares will be offered, and which employees will be eligible for the options. The company’s shareholders must then approve the plan, after which point it typically stays in place for up to ten years, unless further changes are made, at which point a new plan must be approved.
There are certain regulations governing statutory stock options. One such regulation states that the price at which shares are offered must meet or exceed the fair market value of the shares at the date the option was granted. For example, if company A’s stock is worth $6 U.S. Dollars (USD) on 1 January 2010, and that same day the company grants employee Y an option to buy up to 10,000 shares under its statutory stock option plan, the option price must be set at least $6 USD per share. The potential advantage to the employee, and part of why these options are also called incentive stock options, is that employees usually have up to ten years to exercise their options. Therefore, if employee Y exercises his or her option at a later time when company A’s stock is worth more, such as $12 USD share, he or she will still only pay $6 USD per share. Other regulations for statutory stock options include the requirement of the employee to hold the stock for at least two years after receiving the option from the company and at least a year after exercising the option.
In addition to offering employees a potential opportunity to buy company stock at a discounted price, statutory stock options also generally have certain tax benefits for employees when compared to non-statutory stock options. For example, when employees exercise their statutory stock options, any difference between the option share price and fair market value is not counted as income, as it normally would be with a non-statutory stock option. Also, when employees sell their shares, as long as they have held on to the stock for the required minimum times, any profits can be taxed as capital gains or under the alternative minimum tax rather than being taxed at a higher rate as regular income.