Stock Options

Ever wonder how CEOs and other executives get really rich really fast? Well no more. Welcome to the wonderful world of stock options.

Salary and stock granted as compensation are taxed as ordinary income but not stock options because the option may never be exercised.

Incentive stock options which are awarded to CEOs and executives are known as statutory stock options.

From IRS Topic no. 427, Stock options:

"Options granted under an employee stock purchase plan or an incentive stock option (ISO) plan are statutory stock options."

Also from IRS Topic no. 427"

"If your employer grants you a statutory stock option, you generally don't include any amount in your gross income when you receive or exercise the option. However, you may be subject to alternative minimum tax in the year you exercise an ISO...You have taxable income or deductible loss when you sell the stock you bought by exercising the option. You generally treat this amount as a capital gain or loss. However, if you don't meet special holding period requirements, you'll have to treat income from the sale as ordinary income."

So stock options have two advantages. First, you get to buy the stock at below market value because options are almost always discounted. Second, assuming you meet the holding period requirements which are typically pretty modest, the compensation is treated as Long Term Capitol Gains rather than ordinary income. Hell, if you hold onto the stock no taxes may be paid for 10, 20 years.

If you think this is fair, then so be it. I think it's insane that we have store clerks paying normal income tax while CEOs get millions in compensation that they only pay LTCGs on or perhaps no tax at all for years.