Startups have three choices for equity compensation, incentive stock options, non-qualified stock options and restricted stock described below (Hutchinson and Mason).
             Incentive stock options: Incentive stock options can only be grated to employees of a company and must be granted at an exercise price equal to or above fair market value on the date the stock is granted. Incentive stock options are usually subject to a vesting period where an employee can buy a specified number of shares according to a time schedule. These types of stock options provide more generous tax terms to employees than do non-qualified stock options. Employees pay capital gains tax on the different between the sales price and the exercise price of the stock.
             Non-qualified stock options: While most companies attempt to allocate incentive stock options to employees because of their favorable tax treatment, non-qualified stock options may be made available to directors and other categories of non-employees. These stocks may be granted below fair market value. Like incentive stock options, non-qualified stock options are also typically subject to a vesting period. The holder is subject to both income tax and capital gains tax. Income tax will be equal to the difference between the exercise price and fair market value while capital gains will be the difference between the sales price and fair market value of the stock.
             Restricted stock: A company's founders are often offered restricted stock that provides voting and other rights of stockholders. Restricted stock is typically subject to a repurchase right for some period of time that allows the company to repurchase a portion of the founder's stock if employment is terminated by the company for cause, or if the founder voluntarily resigns within a certain period of time. Restricted stock is subject to income tax on the difference between the purchase price of shares and the fair m...