Background

  • An incentive stock option plan must be in writing and have shareholder approval.
  • Option holders have ten years to exercise their options from the date that the employer grants them. If one leaves the company due to retirement or severance, s/he has three months in which to exercise his or her options.
  • Unlike stock options which trade on an exchange, incentive stock options may only be granted to company employees and are not transferable during the employee's lifetime. However, upon death, such options may, in fact, be transferred by will.
  • At the time that they are granted to the employee, the options may not have a strike price that is less than the fair market of the company's stock. In option parlance, the options are out of the money.
    - An option is out of the money when purchasing it would not be profitable. For example, if UVW stock were trading at $8 per share and an employee held options to purchase it at $10, exercise would be unprofitable as one could purchase the shares at $8 in the open market, $2 less than the $10 strike price of the option. Once the share price exceeds both the strike price and any transaction costs, then the option is said to be in the money as one would be able to sell the shares at a price greater than the strike price.
  • In a single year, an employee may not receive options in excess of $100,000.

Tax Implications

  • Grant - no taxable event is triggered when options are granted as the strike price and market price are nearly identical.
  • Exercise - this refers to when the employee purchases the shares at the strike price. If the option is in the money, that is, the current market value of the shares exceeds the strike price, then the holder may be subject to payment of the alternative minimum tax. In company stock option parlance, the extent to which the option is in the money at exercise is termed the bargain element.
  • Basis - in its simplest form, basis refers to the cost of acquiring something. For stock options, taxable basis is the strike price. For the purpose of calculating the alternative minimum tax, basis refers to the strike price and any appreciation on the date of exercise.
Sale of Incentive Stock Options

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