Earlier, we talked about stock options. Now, we’re going to delve deeper into Nonstatutory (Nonqualified) and Statutory Stock Options. The differences between the two are fairly clear, and generally the statutory stock options are preferred for beneficial tax treatment, if the options qualify.
Statutory Stock Options
Unless they qualify as statutory stock options, also sometimes called employee incentive stock options (ISOs), stock options will default to nonstatutory.
The two types of stock options are taxed very differently. The statutory stock option has the generally favorable tax treatment for the employee. Under this type of stock option plan, there is no reported income when the stock option is granted, nor is there a tax consequence when the stock option is exercised. The only tax consequence is reported when the employee sells the stock, and depending on how long you own those shares, the tax is either capital gains or ordinary income. The ordinary income comes with your marginal tax bracket and FICA taxes, so it is far better to hold onto the shares long enough to avoid the income being reported as ordinary income.
Statutory Stock Options have far more formal requirements in order to maintain their favorable tax treatment. One of these requirements is that the exercise price be at or above the fair market value of the stocks at the time the option is granted. Additionally, when the option is exercised, the employer must provide a Form 3921, and then a Form 3922 after the first sale or transfer.
If the statutory stock option is to a person not currently employed by the company, the company must provide three months after termination or departure to exercise the then vested portion of the options. Statutory Stock Options cannot be granted to non-employees or independent contractors.
There are also specific rules if the option holder owns more than 10% of the company, and there are limits to the amount of value of exercisable stock options that can be redeemed in a calendar year.
For Statutory Stock Options, the company providing them must have the purchase price at least at fair market value, and that company should be able to prove this valuation through a generally accepted means in case the IRS audits the company.
This article only skims the surface regarding the differences between statutory and nonstatutory stock options. When it comes to issuing these, you should not do so without an attorney and a CPA. The penalties for doing them wrong can cost you far more than the price of the options.