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In recent years, the level of legal, accounting, and regulatory complexity associated with employee stock options has continued to grow. This book, written by attorneys Alisa Baker and Alison Wright, and writer and editor Pam Chernoff, CEP, presents a straightforward, comprehensive overview of both the big-picture issues and the technical details related to designing and implementing stock option plans and employee stock purchase plans. The book also looks at hot issues and provides illustrative exhibits, a glossary, a bibliography, and primary source materials, plus a seminal article by Corey Rosen on plan design.
The 22nd edition (2022) updates most of the chapters, and includes changes related to Section 162(m) and pending changes that may affect the availability of Forms S-8 and Rule 701.
"Anyone involved with the design or administration of employee stock option programs, from the inexperienced stock plan administrator to the seasoned compensation professional, will appreciate this useful reference tool."
- Tim Sparks, President, Compensia, Inc.
"This book should be on the desk of every stock option professional."
- Robert H. (Buff) Miller, Cooley Godward Kronish LLP
Table of Contents
Part I: Overview of Stock Options and Related Plans
Chapter 1: The Basics of Stock Options
Chapter 2: Tax Treatment of Nonstatutory Stock Options
Chapter 3: Tax Treatment of Incentive Stock Options
Chapter 4: Plan Design and Administration
Chapter 5: Employee Stock Purchase Plans
Chapter 6: Trends in Equity Compensation: An Overview
Part II: Technical Issues
Chapter 7: Financing the Purchase of Stock Options
Chapter 8: Overview of Securities Law Issues
Chapter 9: Tax Law Compliance Issues
Chapter 10: Basic Accounting Issues
Chapter 11: Tax Treatment of Options on Death and Divorce
Chapter 12: Post-Termination Option Issues
Part III: Current Issues
Chapter 13: Legislative and Regulatory Initiatives Related to Stock Options: History and Status
Chapter 14: Cases Affecting Equity Compensation
Chapter 15: Transferable Options
Chapter 16: Reloads, Evergreens, Repricings, and Exchanges
Appendix 1: Designing a Broad-Based Stock Option Plan
Appendix 2: Primary Sources
From Chapter 3, "Tax Treatment of Incentive Stock Options" (footnotes omitted)
Unlike NSOs, ISOs can be granted only to persons who are employees rendering services to the company or who are employees of a “parent” or “subsidiary” corporation as such terms are defined in Section 424(f) of the Code. “Employee” is defined by reference to the common-law definition of employee as it applies for purposes of withholding under Section 3402 of the Code. Thus, ISOs generally cannot be granted to persons who serve as independent contractors, consultants, or outside directors to the company since they are not employees. A question that frequently arises is whether ISOs may be granted to employees of a corporate entity in which the granting corporation has a “joint venture” interest. The Code is clear on this point: unless the corporation’s stake is at least 50% (i.e., the joint venture satisfies the statutory definition of subsidiary), the joint venture employees are not eligible to receive ISOs under the granting corporation’s plan.
In addition, to receive ISO tax treatment, the optionee must be an employee of the company at the time of exercise or have terminated employment with the company no more than three months before the date of exercise (or 12 months in the case of a person whose employment was terminated by permanent and total disability within the meaning of Section 22(e) of the Code). In the case of a leave of absence, the regulations provide that for ISO purposes the employment relationship will terminate after three months of leave unless the individual has the right to continued employment with the company under either contract or statute (e.g., the Family and Medical Leave Act or Uniformed Services Employment and Reemployment Rights Act of 1994). Accordingly, persons whose employment with the company is terminated will be able to exercise ISOs only for a limited period of time. If the employee dies, the Code places no time limit on exercise by the estate other than the option’s existing expiration date. Note that these are statutory maximums. The company granting the option is free to set more restrictive limits on post-termination exercise, so long as it is not subject to other statutory limitations such as state corporate or securities law limits. For example, the California rules state that when termination occurs other than for cause, an optionee must have a minimum of 30 days (and, in the case of death or disability, a minimum of six months) within which to exercise an option post-termination.
In the case of an assumption or substitution of an ISO pursuant to a corporate transaction, both current employees and former employees who are still within the three-month post-termination exercise period will qualify to receive ISOs in connection with the transaction. Optionees on leave pursuant to a statute or contract that provides for continuing rights of re-employment also continue to be considered employees for these purposes.
From Chapter 10, "Tax Treatment of Options on Death and Divorce" (footnotes omitted)
After a divorce, the employer company is frequently asked to split an outstanding option between its employee and a nonemployee former spouse (NEFS). The company’s ability to effect a split depends on: the state the couple lived in, the type of option being split, and the terms contained in the plan document. Without specific authorization in the plan or option grant, the company cannot legally permit the transfer of a nontransferable option to the NEFS, even pursuant to a divorce decree without an amendment to the plan documents, which generally would require compensation committee approval. Where the property settlement directs the transfer of nontransferable options, the company may need to request clarification from the appropriate court. In situations where the option is not transferrable, the ex-spouses should agree that the employee spouse will exercise on behalf of the NEFS, with a subsequent transfer of the stock (see below). The company may deposit the stock issued on exercise directly to the account of the NEFS if the employee and NEFS are in contact with the company prior to exercise and complete any required paperwork.
ISOs pose a particularly tricky case in that unexercised ISOs transferred incident to divorce decree or domestic relations order are automatically disqualified and treated as NSOs, even though a similar transfer of stock that was acquired upon exercise of an ISO is not a disqualifying disposition.
To address this issue, the IRS has recognized that in community property states, the former spouses may agree to transfer the benefits of the ISO without actually transferring the instrument itself. In a 2007 private letter ruling, the IRS allowed continuing ISO treatment for a division of community property in which the employee spouse continued to hold ISOs as trustee for the NEFS. The NEFS was entitled to direct the employee spouse as to when to exercise the option, but only the employee could actually accomplish the exercise. After the exercise, the stock would be transferred to the NEFS. The IRS affirmed that the arrangement would not violate the requirement that ISOs may be held only by employees. For reporting purposes, the NEFS would report the alternative minimum tax (AMT) income relating to the exercise of the ISO. After exercise, the transfer of the shares from the employee spouse to the NEFS would be treated as a non-event for tax purposes. From that point, the NEFS would have the benefits of ISO treatment on disposition of the shares, including with respect to AMT credits.