7545 / What is an incentive stock option?

(1) The option is granted pursuant to a plan that specifies the number of shares to be issued and the employees or class of employees to receive the option. The plan must be approved by the stockholders of the corporation within 12 months before or after the date the plan is adopted;

(2) The option is granted within 10 years of the date the plan is adopted or approved by the shareholders, whichever occurs first;

(3) The option must, by its terms, be exercisable within 10 years of the date it is granted;

(4) The exercise price of the option is not less than the fair market value of the stock at the time it is granted;

(5) The option is nontransferable and exercisable only by the transferee (except that it may be transferred by will or the laws of descent and distribution); and

(6) The grantee of the option may not own stock representing more than 10 percent of the voting power of all classes of stock of the employer corporation, or its parent or subsidiary corporation. There is an exception to this rule where (i) the option price is at least 110 percent of the fair market value of the stock subject to the option, and (ii) the option is exercisable only within five years after it is granted.¹

In determining the extent of an individual’s ownership of stock for purposes of the
10 percent limitation, an individual will be considered to own stock of the employer corporation
or of a related corporation that is owned (directly or indirectly) by the individual’s brothers, sisters, spouse, ancestors, and lineal descendants.²

If the stock covered by options that may be exercised by any individual employee for the first time in a calendar year (under all plans of the employer corporation, and its parent and subsidiary corporations) has an aggregate fair market value that exceeds $100,000, the excess options may not be treated as incentive stock options. For purposes of the $100,000 limitation, the options are taken into account in the order in which they were granted, and their fair market value is determined as of the date the option was granted.³