What is a Grant
A grant is an award, usually financial, given by one entity (typically a company, foundation, or government) to another, often an individual or a company, to facilitate a goal or incentivize performance. Grants are essentially gifts that do not have to be paid back, under most conditions. These can include education loans, research money, and stock options.
For businesses, a grant usually refers to the award of options on the company's stock given to an employee to elicit loyalty and incentivize strong job performance. Sometimes, actual shares of stock are granted. After the waiting period, the employee can then exercise these stock options, or sell granted shares.
BREAKING DOWN Grant
Stock option grants are usually offered to employees after they have worked at the company for a set period of time. Each company decides how its grant program operates, but most of the time employees must continue to work for the company and cannot exercise their granted options (sell their granted shares) for a set period of time.
Often, grants follow a vesting schedule where rights to the financial rewards accrue over time. For example, an employee remains with the company and becomes 50% vested in the reward. At that point, the employee has nonforfeitable rights to half the reward, even if employment is ended.
For more details on stock option grants and tips on determining the best time to exercise them, read CNN Money's "Employee stock option plans."
Why Offer Stock Option Grants?
From the employer's standpoint, the idea behind stock option grants is to give employees the incentive to align their interests with that of the shareholders.
From the employee's standpoint, a stock option grant is an opportunity to purchase stock in the company for which he or she works at a lower price. Typically, the grant price is set as the market price at the time the grant is offered. It is advisable for an employee to purchase a stock option if the market price of the stock goes up in value: the grant price is still the same, so the employee is purchasing a stock at a lower price than market value. In this way, grants are similar to call options, but without an expiration date.
Qualified vs. Non-Qualified Stock Option Grants
Non-qualified stock option (NSO) grants can be transferred to a child or a charity, depending on the specific company's policies. Non-qualified stock option grants are tax deductible by the company that provides them. Since the grant is provided at a specific price, which is usually lower than the market value for the company's stock, employees who choose to take advantage of this opportunity pay income tax on the difference between these two prices upon purchase. It's important to note that employees are not subject to taxes when the option becomes available to them; instead they only pay taxes when they purchase a stock option.
For a breakdown on exactly what determines a non-qualified stock option and how it is taxed, read Non-Qualified Stock Options.
A qualified stock option grant, also known as an incentive stock option (ISO), is eligible for a special tax treatment: you don't have to pay income tax when you purchase an option, you instead pay capital gains tax when you sell the option, or taxes on the profits made from the stock option. However, the grant might not be provided at a lower price than market value, as non-qualified options are. Also, this type of grant is riskier, as the employee must hold on to the option for a longer period of time to qualify for this tax treatment. This type of grant is usually reserved for the higher level employees, and the company cannot write it off as a tax deduction. ISOs cannot be transferred to another person or entity, unless through a will or trust.
To learn more about how ISOs work and how they are taxed, read Introduction To Incentive Stock Options.