Taxation of Stock Options and Restricted Stock Units (RSUs)

Stock options and restricted stock units (RSUs) are common forms of equity compensation offered by companies to employees as part of their compensation package. Understanding the taxation implications of these equity awards is essential for employees to effectively manage their financial affairs.

Stock Options: Stock options give employees the right to purchase company stock at a predetermined price, known as the exercise or strike price, within a specified period. There are two main types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs).

Taxation of ISOs: Generally, ISOs are not taxed upon grant or exercise. However, when the employee sells the stock acquired through the exercise of ISOs, the difference between the exercise price and the fair market value of the stock at the time of exercise (the "spread") may be subject to capital gains tax.

Taxation of NSOs: NSOs are subject to ordinary income tax on the difference between the fair market value of the stock at the time of exercise and the exercise price. Additionally, any gain realized upon the sale of the stock is subject to capital gains tax.

Restricted Stock Units (RSUs): RSUs represent a promise by the employer to deliver company stock to the employee at a future date, subject to certain vesting conditions. RSUs do not carry the same rights as actual stock until they vest.

Taxation of RSUs: RSUs are typically taxed as ordinary income upon vesting based on the fair market value of the stock on the vesting date. Employees may have the option to defer the receipt of the shares upon vesting, but the deferral may trigger additional tax consequences.

Objective Question:

What is the primary difference between the taxation of incentive stock options (ISOs) and non-qualified stock options (NSOs)?

A) ISOs are taxed upon exercise, while NSOs are taxed upon vesting.

B) ISOs are subject to capital gains tax, while NSOs are subject to ordinary income tax.

C) ISOs have no tax implications, while NSOs are taxed as ordinary income.

D) ISOs have a higher exercise price than NSOs.

Please choose the correct option and provide a brief explanation of your choice