Stock options are a form of compensation that allow employees to acquire company stock at a discounted price. Understanding the different types of stock options available is essential for making the most of this valuable form of compensation.

There are two main types of stock options: incentive stock options (ISOs) and non-qualified stock options (NSOs). ISOs are available only to employees and are subject to certain federal tax rules. NSOs are available to employees and non-employees and are not subject to the same tax rules.

ISOs are granted to employees at a discounted price, usually below the current market price. They are usually granted with a vesting period, which means the employee must remain with the company for a certain period of time before they can exercise their option. When the option is exercised, the employee pays the discounted price, and any difference between that price and the current market price is taxed as a long-term capital gain.

NSOs are also granted with a discounted price, but the discount is usually smaller than that of an ISO. NSOs are not subject to the same tax rules as ISOs and are taxed as ordinary income when the option is exercised.

Employees may also receive restricted stock options. These are stock options that are granted with a vesting period and a limit on the number of shares that can be sold or transferred before the vesting period has expired. The employee must remain with the company for the vesting period before they can exercise the option.

Finally, employees may receive employee stock purchase plans (ESPPs). ESPPs allow employees to purchase company stock at a discounted price, usually at a rate lower than the current market price. The employee pays the discounted price, and any difference between that price and the current market price is taxed as a long-term capital gain.

Understanding the different types of stock options available is essential for making the most of this valuable form of compensation. ISOs are generally the most advantageous type of stock option, since they are subject to favorable tax rules. NSOs and restricted stock options are also valuable forms of compensation, but ESPPs may not be as advantageous since they are taxed as ordinary income.

No matter which type of stock option is offered, it is important to understand the details of the plan and the associated tax implications. Knowing how stock options work and how they are taxed can help employees make the most of their incentive stock options, non-qualified stock options, restricted stock options, and employee stock purchase plans.