ISOs are not taxed at the time the stock option is exercised; instead, income is reported when the stock is sold at a later date. This is often favorable for the employee. However, when an ISO is sold it may be subject to capital gains tax, and the alternative minimum tax in some cases. Companies that use ISOs may receive a tax deduction, but only if certain conditions are met.
Nonqualified stock options Nonqualified stock options can be offered to external personnel such as consultants or external board members, as well as to employees. Companies that use nonqualified stock options receive a tax deduction when the options are exercised, and employees pay tax on any profit they make from the sale. Income from the stock is treated as compensation, so there are usually further tax implications when the stock is sold.
Restricted stock Restricted stock is common stock that is typically offered to executives, or to high-performing employees. Unlike stock options, which offer only the option to purchase shares, restricted stocks are actual shares. The vesting schedule of restricted stock is usually designed to encourage the retention of employees until they can reap the full benefit of their shares. For this reason, employees often perceive these shares as "golden handcuffs", or a financial benefit that will be lost if they leave the company.
Phantom stock Phantom stock is used to offer employees the motivation and benefits of stock ownership without actually granting any equity or stock in the company. It is most commonly offered to executives and external board members. Phantom stock can yield the same kinds of payouts as stock options or restricted stock. The vesting schedule is usually based on the length of the employee's service as well as individual and company performance. When the phantom stock yields a payout, the employer receives a tax deduction for the amount paid.
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