New York, NY -
From dot coms to blue chip companies, stock options give employees the chance to purchase their company stock at a special price. For some employees, stock options are a big part of the compensation package.
There are two types of options - qualified and non-qualified. Non-qualified stock options are always taxed as ordinary income-as high as 36%. But qualified options, if managed properly, are taxed as long-term capital gains-only about 20%. But you must buy and sell the stock within a 2-year period.
"The main advantage of a qualified option is when you receive the grant of the option, and when you exercise it, there isn't a taxable event," said James Cotto of Merrill Lynch. "The taxable event occurs upon selling the stock and that is taxed as a capital gain. So the main advantage is if you hold your option for two-year period or exercise your option after one year and then sell the stock in a year, it is viewed as a long term capital gain."
The difference between the types of options-qualified and nonqualified is how each is issued.
"Non-qualified options are not issued under the internal revenue service code," Cotto said. "So, when they are exercised they come out in a taxable event automatically, in the year in which you exercise them, and they are taxed as ordinary income."
But if you're a new employee-looking to construct a compensation package, it may be a good idea to ask if the company offers qualified stock options. The potential tax advantage could be well worth it in the long run.