Chapter 36
INCENTIVE STOCK OPTIONS
LEARNING OBJECTIVES:
A. Describe key factors related to incentive stock options
REVIEW:
This chapter discusses incentive stock options – the tax-favored plan which does
not normally result in taxable income either at time or grant or at exercise.
Advantages and disadvantages are covered, with the primary benefits being one
of preferred tax treatment and no real out-of-pocket cost to the company. The
section on tax implications targets the Section 422 rules for preferred/deferred
tax treatment. There is also an alert for possible AMT. The chapter closes with
two references on where to learn more.
CHAPTER OUTLINE:
A.
B.
C.
D.
E.
F.
G.
What is It?
When Is it indicated?
Advantages
Disadvantages
Tax Implications
Where Can I Find Out More About it?
Chapter Endnotes
FEATURED TOPICS:
Incentive stock options
1
Chapter 36
CFP® CERTIFICATION EXAMINATION TOPIC:
Topic 31: Employee stock options
B. Incentive stock options
COMPETENCY:
Upon completion of this chapter, the student should be able to:
1. Describe key factors related to incentive stock options
KEY WORDS:
incentive stock option, Internal Revenue Code section 422, alternative minimum
tax (AMT)
DISCUSSION:
1. Discuss advantages and disadvantages of using an ISO rather than a
nonstatutory stock option plan.
2. Discuss the Section 422 rules for deferred taxation, and how they may
impact the option holder.
QUESTIONS:
1. What benefit is gained by offering an ISO?
(1) there may be AMT when an ISO is exercised
(2) the ISO provides greater tax deferral than a nonstatutory option
(3) income from sale of stock received at exercise may be eligible for
preferential capital gain treatment
(4) the company has little or not out-of-pocket cost with an ISO
a.
b.
c.
d.
(1) only
(1) and (2) only
(1) (2) and (3) only
(2) (3) and (4) only
Chapter 36, p. 291
Chapter 36
2. What is the minimum allowable exercise price of the option?
a.
b.
c.
d.
fair market value of the stock on date of exercise, less 25%
option price plus 25% of the current market price
fair market value of the stock on the date the option is granted
one-half the current fair market value of the stock
Chapter 36, p. 292
3. For how long must stock acquired by an employee under the ISO must be
held in order to satisfy Section 422 regulations?
(1) at least two years after the option grant
(2) one year from the date stock is transferred to the employee
(3) until the fifth year of employment
(4) one year after the option grant
a.
b.
c.
d.
(1) only
(1) and (2) only
(1) (2) and (3) only
(2) (3) and (4) only
Chapter 36, p. 292
4. What amount is included in the executive’s AMT calculation when an ISO is
exercised?
a. excess of the stock’s fair market value over the option price at time of
exercise
b. excess of the option price over the stock’s fair market value at time of
exercise
c. option price of stock at time of grant
d. fair market value of stock at time of grant
Chapter 36, p. 292
ANSWERS:
1. d
2. c
3. b
4. a