Stock Options

• Employee stock options are a financial contract stating that the employee can purchase company stock at the price specified in the contract -- almost always the price of the company's shares on the day the contract was signed -- at a specified date in the future, usually one to five years. Companies grant two types of employee stock options: incentive, which carry favorable tax rates and generally go to executives, and non-qualified, which go to everyone else.
  
  

Extra Compensation

• If your employer has offered non-qualified stock options as part of your compensation or benefits package, you stand to gain significantly if the company grows and remains profitable, which will cause its share price to climb and hence grow your bonus. Once the options vest (reach the window of time when you can use them to buy stock), you can either buy at the contract price and sell immediately, pocketing the difference, or hang onto the company stock, which will hopefully continue to gain in value. However, when you use non-qualified options, the difference between the contract price and the market price counts and is taxed as income.
  
  

Transferability

• If you already have incentive stock options and are considering switching some or all to non-qualified options, you essentially stand to gain one thing. Incentive stock options cannot be transferred to anyone per the U.S. Security and Exchange Commission's rules. Non-qualified options, however, can be transferred to immediate family members, which helps in estate planning and other family law arrangements dealing with finances. The Internal Revenue Service considers incentive options to be capital goods and taxes them as such -- generally at a 15 percent rate -- whereas any initial profit from non-qualified options get taxed as income.
  
  

For Companies

• Granting non-qualified options to employees as part of compensation packages offers a number of advantages to companies as well. Companies must expense the options, and while that will affect the profit reports, granting options costs less than giving the employee the same amount in a cash bonus (and non-qualified options cost less than incentive options). Furthermore, employees stand to make more money if the company performs well, which acts as a very effective work incentive.