What To Expect In An Employee Share Option Plan

An Employee Share Option Plan (ESOP) is also known as the ESS or an Employee Share Scheme wherein employees receive stocks offering from the company. This scheme is usually offered to key employees who have made a great contribution to the company. 

When an employee accepts such an offer, the employer will put in writing the options for shares they can have. In terms of stock options, employees can choose either the following: 

• Non-qualified Stock Option (NSO) – This stock option, also known as a non-statutory stock option, is taxed because the profit from such is labeled as ordinary income. In this type of stock option, all employees can avail of such.

• Incentive Stock Option (ISO) – This type of stock option, also known as a qualified or statutory option, is limited to top management and key employees. Because the IRS considers the gains on this stock option as long-term capital gains, employees with such a stock option receive preferential tax treatment.

Here are the things to consider with stock options:

Taxation

Getting a stock option has its benefits, and one of these is the privilege of buying stocks at a strike price or fixed price based on the ESOP in the future. As mentioned, ESO is in writing, and companies nowadays usually use ESS software like cake to manage who gets their shares. The ESO plan includes the number of years you can get the stock option as well as the grant price. For instance, the grant price indicated in writing amounts to USD$20 per share with a minimum of 500 shares within 1/1/2030. If you plan to buy the shares any year as long, as it’s not after the expiration date 1/1/2030, you can buy such shares at USD$20 even if the current market price is at USD$30.  

Whatever type of stock option you prefer, expect to pay taxes. Here’s how taxation works on the two stock options: 

• NSO – This type of stock option is automatically taxable when the fair market value is determined. It means that when they’re traded in an exchange, NSO is taxed. You’ll also be reporting it on your W2 tax form as part of your ordinary wage income which also incurs tax.

• ISO – For this type of stock option, there’s no tax unless it produces an income. Similar to NSO, you can receive an income from ISO if you sell it. By that time, it’s also taxed.

Value of ESOs

The ESO’s value comprises time and intrinsic value. Time value is dependent on the remaining time until the share option’s expiration. Because ESOs are non-traded options, the market price isn’t available, making time value calculation more challenging. 

If you want to calculate your ESO’s time value, you need to factor in risk-free interest rate, stock price, time remaining, and exercise price. By doing so, you can get its fair value and, eventually, the intrinsic value.  

However, you can still calculate the intrinsic value if you have a market price at hand for the share option. For instance, the share option’s market price is USD$40, while the price the company offers in the ESOP is USD$20. The intrinsic value for each share will be USD$20 if you’ll sell the shares with USD$40 market price. 

Calculating the value of your ESO isn’t easy, so you may need to use option pricing models. That way, you can have an idea of your ESO’s value. 

Conclusion

Getting an ESO may be a good investment because it allows you to own shares of your company. If they offer it to you at a low price, and it gets high as time pass by, then you’re likely to gain much. However, you need to consider how these share options are taxed. You should also mind how the value of such share options are calculated, so you’ll know if it’ll be worth your money.