So you are at the point in your company where you want to issue stock options and you have heard that there are Incentive Stock Options (ISOs) and Nonstatutory Stock Options (NSOs) and you wonder what the difference might be. There is one very big difference between the two. ISOs are taxed when the underlying stock is sold and NSOs are taxed when the option is exercised. This can delay your tax burden by a long period of time. There are all kinds of issues about capital gains versus ordinary income and other tax consequences to exercising options, but that is for another discussion.
Keep in mind that there are multiple criteria that must be followed for ISOs. For instance, an ISO can only be issued to an employee. Make sure you follow all of the requirements for ISOs versus NSOs and get professional help with the appropriate agreements.
Other factors to consider are that the issuing Company is entitled to a tax deduction in the amount of the spread upon exercise of an NSO. Under an ISO, the issuing Company is entitled to a tax deduction only during a cashless exercise of the option or some other disqualifying disposition of the option. These differences also come into play during the calculation of dilutive EPS.
Posted by: Brian Nenninger, CPA | December 23, 2008 at 02:54 PM