What Is a Statutory Stock Option?

A statutory stock option is a type of employee stock option (ESO) that, unlike unqualified or nonstatutory stock options, gives participants an additional tax advantage. This type of employee compensation may be compared with incentive stock options (ISO), which are only handed out to top management for retention or to reward performance.

Key Takeaways

  • Statutory stock options are a type of employee stock compensation that must come with a plan document denoting how many options are allotted to which employees.
  • Statutory stock options provide an additional tax advantage that unqualified or nonstatutory stock options don’t offer.
  • Employees must exercise statutory stock options after a vesting period, which may be as long as 10 years after receiving them.
  • Their exercise does not result in immediate declarable taxable income.

Understanding Statutory Stock Options

Many employers provide perks such as statutory stock options to their employees. Also referred to as incentive stock options (ISOs), they are used as a way to attract potential new employees or encourage existing employees to remain with the company.

In essence, the company shares a portion of its profits with its employees. This gives participating staff an extra incentive to ensure the company succeeds, while receiving an additional form of compensation on top of their regular salary.

Statutory Stock Option Requirements

Statutory stock options require a plan document that clearly outlines how many options are to be given to which employees. Those employees must exercise their options within 10 years of receiving them.

The option's exercise or strike price cannot be less than the market price of the stock at the time the option is granted. Additionally, statutory stock options cannot be sold until at least a year after the exercise date and two years after the date the option is granted.

Before an employee can exercise these options, there is a vesting period that must pass. This period is usually longer than nonqualified stock options, otherwise the tax implications increase.

Options are issued on the grant date, but the date on which employees can exercise their rights to buy the options is the exercise date.

The taxation of statutory stock options can be somewhat complicated. The exercise of statutory stock options will not result in immediate declarable taxable income to the employee—one of the chief advantages of this type of option. Capital gains tax is later paid on the difference between the exercise and sale price. This type of option is also considered one of the preference items for the alternative minimum tax.

According to the Internal Revenue Service (IRS), when employers grant their employees statutory stock options, employees typically do not include any amount in their gross income when they receive or exercise the option. Despite that fact, employees who receive a statutory stock option may fall under the alternative minimum tax for the year in which their statutory stock options are exercised.

Statutory stock options can trigger the alternative minimum tax for the year in which they are exercised.

Tax Considerations

When the stock acquired through exercising the option is later sold, the employee will have taxable income or a deductible loss as a result. This is typically rated as a capital gain or loss. The assumption is that the price of the stock option will be lower than the market price at the time the option is exercised, which would allow the employee to possibly sell the asset for a profit.

If the employee does not meet special holding-period requirements—meaning they sold the shares before one year passed since the exercise date—the income from that sale must be handled as ordinary income. That amount is also added to the basis of the stock in order to calculate the loss or gain on the disposition of the stock.

With an employee stock purchase plan, after the stock acquired by exercising an option is transferred or sold for the first time, employees should furnish forms from their employer that include information for determining the ordinary and capital income that must be reported.