Compensatory Stock Options Law and Legal Definition

Compensatory Stock Options are options offered to employees as partial compensation for their services. Compensation for services is measured by the quoted market price of the stock at the measurement date less the amount the employee is required to pay (option price).

For income tax purposes, there are two types of stock options-incentive stock options (ISOs), sometimes called statutory options or qualifying options, and the nonqualified options (NQOs).

Incentive stock options allow employees to receive option compensation potentially as long-term capital gain with a delay in the recognition of all income taxes until the sale of the stock received from the exercise of the option.

An ISO plan may provide that the employee can pay the option price on exercise by surrendering shares of presently owned employer stock having a fair market value equal to the option price. This feature can further delay taxation of gain related to employer stock if the employee would otherwise need to sell appreciated employer stock to pay the exercise price related to ISOs.