Incentive Stock Option (ISO)
An Incentive Stock Option (ISO) is a stock option (typically a U.S. stock option) that confers a U.S. tax benefit.
- AKA: Qualified Stock Option (QSO).
- Context:
- It can result in no income is reported when the Option is Exercised.
- It can, if certain requirements are met, the entire gain when the stock is sold is taxed as Long-Term Capital Gains.
- …
- Counter-Example(s):
- See: Alternative Minimum Tax, Tax Deferral.
References
2015
- (Wikipedia, 2015) ⇒ http://en.wikipedia.org/wiki/incentive_stock_option Retrieved:2015-6-8.
- Incentive stock options (ISOs), are a type of employee stock option that can be granted only to employees and confer a U.S. tax benefit. ISOs are also sometimes referred to as incentive share options or Qualified Stock Options by IRS. The tax benefit is that on exercise the individual does not have to pay ordinary income tax (nor employment taxes) on the difference between the exercise price and the fair market value of the shares issued (however, the holder may have to pay U.S. alternative minimum tax instead). Instead, if the shares are held for 1 year from the date of exercise and 2 years from the date of grant, then the profit (if any) made on sale of the shares is taxed as long-term capital gain. Long-term capital gain is taxed in the U.S. at lower rates than ordinary income.
Although ISOs have more favorable tax treatment than non-ISOs (aka non-statutory stock option (NSO) or non-qualified stock option (NQO or NQSO)), they also require the holder to take on more risk by having to hold onto the stock for a longer period of time if the holder is to receive optimal tax treatment. However, even if the holder disposes of the stock within a year, it is possible that there will still be marginal tax deferral value (as compared to NQOs) if the holding period, though less than a year, straddles the ending of the taxpayer's taxable reporting period.
Note further that an employer generally does not claim a corporate income tax deduction (which would be in an amount equal to the amount of income recognized by the employee) upon the exercise of its employee's ISO, unless the employee does not meet the holding-period requirements. But see Coughlan, Section 174 R&E Deduction Upon Statutory Stock Option Exercise, 58 Tax Law. 435 (2005). With NQSOs, on the other hand, the employer is always eligible to claim a deduction upon its employee's exercise of the NQSO.
Additionally, there are several other restrictions which have to be met (by the employer or employee) in order to qualify the compensatory stock option as an ISO. For a stock option to qualify as ISO and thus receive special tax treatment under Section 421(a) of the Internal Revenue Code (the "Code"), it must meet the requirements of Section 422 of the Code when granted and at all times beginning from the grant until its exercise. The requirements include:
- The option may be granted only to an employee (grants to non-employee directors or independent contractors are not permitted), who must exercise the option while he/she is an employee or no later than three (3) months after termination of employment (unless the option holder is disabled, in which case this three-month period is extended to one year. In case of death the option can be exercised by the legal heirs of the deceased until the expiration date).
- The option must be granted under a written plan document specifying the total number of shares that may be issued and the employees who are eligible to receive the options. The plan must be approved by the stockholders within 12 months before or after plan adoption.
- Each option must be granted under an ISO agreement, which must be written and must list the restrictions placed on exercising the ISO. Each option must set forth an offer to sell the stock at the option price and the period of time during which the option will remain open.
- The option must be granted within 10 years of the earlier of adoption or shareholder approval, and the option must be exercisable only within 10 years of grant.
- The option exercise price must equal or exceed the fair market value of the underlying stock at the time of grant.
- The employee must not, at the time of grant, own stock representing more than 10% of voting power of all stock outstanding, unless the option exercise price is at least 110% of the fair market value and the option expires no later than five (5) years from the time of the grant.
- The ISO agreement must specifically state that ISO cannot be transferred by the option holder other than by will or by the laws of descent and that the option cannot be exercised by anyone other than the option holder.
- The aggregate fair market value (determined as of the grant date) of stock bought by exercising ISOs that are exercisable for the first time cannot exceed $ 100,000 in a calendar year. To the extent it does, Code section 422(d) provides that such options are treated as non-qualified stock options.
- Incentive stock options (ISOs), are a type of employee stock option that can be granted only to employees and confer a U.S. tax benefit. ISOs are also sometimes referred to as incentive share options or Qualified Stock Options by IRS. The tax benefit is that on exercise the individual does not have to pay ordinary income tax (nor employment taxes) on the difference between the exercise price and the fair market value of the shares issued (however, the holder may have to pay U.S. alternative minimum tax instead). Instead, if the shares are held for 1 year from the date of exercise and 2 years from the date of grant, then the profit (if any) made on sale of the shares is taxed as long-term capital gain. Long-term capital gain is taxed in the U.S. at lower rates than ordinary income.
2012
- https://www.nceo.org/articles/stock-options-restricted-phantom-sars-espps
- QUOTE: A few key concepts help define how stock options work:
- Exercise: The purchase of stock pursuant to an option.
- Exercise price: The price at which the stock can be purchased. This is also called the strike price or grant price. In most plans, the exercise price is the fair market value of the stock at the time the grant is made.
- Spread: The difference between the exercise price and the market value of the stock at the time of exercise.
- Option term: The length of time the employee can hold the option before it expires.
- Vesting: The requirement that must be met in order to have the right to exercise the option - usually continuation of service for a specific period of time or the meeting of a performance goal.
- A company grants an employee options to buy a stated number of shares at a defined grant price. The options vest over a period of time or once certain individual, group, or corporate goals are met.
… There are five basic kinds of individual equity compensation plans: stock options, restricted stock and restricted stock units, stock appreciation rights, phantom stock, and employee stock purchase plans.
- QUOTE: A few key concepts help define how stock options work: