Purchase stock certificate

Final Regs On Incentive Stock Option Plans Fine-Tune Restrictions; Questions Remain For Employee Stock Purchase Plans

* TDNR JS-1819, T.D. 9144, Notice 2004-55

Just as incentive stock options (ISOs) are making a cautious comeback as compensation tools, the 1RS has issued comprehensive final regs to provide a bit more flexibility. While the final ISO regs adopt most of the proposed reliance rules issued in 2003, they loosen or clarify a handful of requirements, including those on shareholder approval, maximum number of shares, option pricing, the employment relationship, and disqualifying dispositions.

In a Notice issued the same day, the 1RS announced that it will separately consider whether final regs on employee stock purchase plan (ESPP) options should follow the ISO rules and if existing ESPP regs should be amended.

* Comment. A qualified stock option (ISO) plan or an employee stock purchase plan (ESPP), collectively known as statutory options, allows an employee to obtain employer stock with no immediate tax consequences either when the option is issued or when it is exercised. Only when the employee sells the shares must tax be paid, and then only at the capital gains rate.

Incentive stock options

An incentive stock option must be granted under a plan approved by the stockholders of the corporation within 12 months before or after the date the plan is adopted. The final regs give specific guidance on new stockholder approval as a result of a change in the shares with respect to which options are issued or a change in the granting corporation.

The option price of an incentive stock option must not be less than the fair market value of the stock at the time the option is granted. The final regs allow any reasonable manner to be used to determine price but appraisals are not permitted. In the case of non-publicly traded stock, independent and well-qualified experts may be used. Even if the ultimate outcome results in an exercise price less than the fair market value, the requirements will be deemed to have been met if there is evidence of a good faith attempt to meet the requirements.

When a disqualifying disposition occurs, the optionee must recognize compensation income in the tax year of the disposition. The final regs clarify that the amount of includible compensation is the fair market value of the stock on the date the stock is substantially vested less the exercise price.

Nonstatutory option mix

If the aggregate fair market value of stock associated with incentive stock options exercisable for the first time by an individual exceeds $ 100,000 in a calendar year, the options are not treated as incentive stock options. A corporation may issue a separate certificate for incentive stock option stock or so designate its records or the plan's records. In the absence of a separate certificate or recordkeeping, shares are deemed purchased under an incentive stock option first to the extent of the $100,000 limitation.

References: FED ?¡ì?¡ì46,704, 47,052, 46,705; FTS ?¡ìB: 8.40.