Incentive Stock Options (ISOs)
Key Provisions
- Employee may buy stock at a specified price (not less than Fair Market Value) for a period of 10 years
- Only employees may receive ISOs
- Option price cannot be less than 100% of Fair Market Value (employee with 5% or more ownership must pay 10% above Fair Market Value)
- Options may be exercised in any sequence
- Annual value of ISOs exercisable (vested) by an individual cannot exceed $100,000 each year
- No tax on the option spread at exercise
- Appreciation from grant to sale qualifies for capital gains
- ISOs subject to a holding period in order to qualify for favorable tax treatment
- Satisfies the conditions of the Internal Revenue Code Section 422 for preferential tax treatment
- Shareholders must approve a written plan specifying the number of shares and class of eligible employees
Tax Impact on Employee
- At grant - no tax
- At exercise - no tax assuming holding requirements are met
- At sale - appreciation from grant price taxed at capital gains rate
- Employee realizes no income upon its receipt or exercise
- In the event of disqualifying disposition, gain becomes part of annual compensation
- Stock must be held for at least 2 years after grant and 1 year after exercise in order to receive favorable long-term capital gains treatment
Tax Impact on Company
- At grant - no tax deduction
- At exercise - no tax deduction
- At sale - no tax deduction unless executive fails to meet holding requirements
- Fair value on grant date is charged to earnings over service/vesting period
Advantages
- Executive's tax liability is deferred until stock is sold
- Long exercise period allows executive flexibility and can be retentive
- Executive may defer taxes or at earlier sale file a disqualifying disposition
- Executive share in the appreciation and the value of the stock.
- Plan can be tailored to benefit particular employees.
Disadvantages
- Executive investment required
- Company loses tax deduction
- Spread at exercise is subject to the alternative minimum tax
- Executives with 5% plus ownership must pay 10% above Fair Market Value
To find out more on how Compensation Resources, Inc. can help your company with your Incentive Stock Options (ISOs), please contact us or call us directly to speak with our compensation consultants at (877) 934-0505.
