Incentive Stock Options (ISOs)
Exercise period
- cannot exceed 10 years from the date of grant. -ISOs must be exercised within three months from the date of retirement or termination.
Taxable basis for regular tax and AMT
- the taxable basis for the regular tax is the option exercise price. -For AMT purposes, the taxable basis is the price of the stock of the date of exercise, which is the option strike price (on date of grant) plus appreciation at the exercise date.
Who can ISOs be granted to?
-ISOs can only be granted to employees of the company at all times between the grant of the option and three months before the date of exercise (twelve months in the case of permanent and total disability, and no limit in the event of death). -ISOs may not be granted to any employee who owns, directly or indirectly, more than 10% of the corporation, unless the term of the option is limited to not more than five years and the exercise price is at least 110% of the FMV of the stock on the date of grant.
ISOs vs NQSOs
-ISOs provide greater deferral of taxes to the executive than NQSO.
ISOs
-Stock options give the employee the right to purchase a fixed number of shares of employer stock at a fixed price, over a stated period of time. -ISOs must be part of a written plan approved by the stockholders.
Employer tax deduction
-The employer does not receive an income tax deduction when an employee exercises an ISO. -if the employee disposes of the ISO shares in a disqualifying dis-position, then the employee will generally have ordinary income and the employer will receive a tax deduction.
Taxation upon exercise
-no regular taxable income. However, there is an AMT adjustment -AMT adjustment (aka bargain element) = (Exercise price) - (Grant price) The -AMT adjustment can be large enough to cause the payment of AMT tax.
Cashless exercise of options taxed as ordinary income
A cashless exercise will result in a disqualifying disposition with respect to the shares sold because the holding requirements are not met. As a result, the employee will recognize ordinary income equal to the excess of the FMV of the stock sold over the exercise price/bargain element.
Transferring ISOs
ISOs are not transferable by the employee during life, but may be transferred at death by will.
Sale of ISOs within calendar year- Taxed W-2 income
If shares are sold within the calendar year of exercise, it is considered W-2 income equal to the difference between the stock strike price (on the date of grant) and the market price of the stock on the date of sale. This is the same treatment as a NQSOs.
Sale of ISOx taxed as LGCG
If sold after 1 year from the date of exercise and 2 years from the date of grant, it is considered a long-term capital gain.
Sale of ISOs taxed ordinary income
If the stock is sold within 1 year from the date of exercise or within 2 years from the date of grant, but not in the calendar year of exercise, the gain is considered ordinary income, but not W-2 income.
To qualify for favorable tax treatment of the ISO
The shares received through the exercise of ISOs cannot be sold within two years from the date of grant or one year from the date of exercise.
Option strike price
cannot be less than the market price of the stock at the time of grant.
Annual limit
is $100,000 on the value of the ISOs granted one year to a single employee.
Grant of a stock option
is generally a nontaxable event because the option price is usually made equal to the stock's market price on the grant date.
Cashless exercise of options
require no cash outlay by the employee. Typically used by employees who do not have liquid assets sufficient to satisfy the exercise price of the option. The arrangement works as follows: (A) - The stock option is exercised by the employee. (B) - After exercise, a sufficient amount of the employer stock is sold to satisfy the exercise price and any other costs associated with the exercise, such as income taxes. (C) - The employee receives the net amount of the stock after the sale of shares, or any remaining cash.
