Capture tax rewards for ISOs

Do you own incentive stock options (ISOs) issued by your company? They can provide big tax benefits if you’re careful.

Strategy: Observe the holding period requirements. If you qualify, any profit from selling stock acquired by exercising your ISO will be favorably taxed long-term capital gain.

The maximum tax rate on long-term capital gain is only 15% or 20% for those in the highest ordinary income tax bracket.

Here’s the whole story: You don’t owe any federal income tax when you exercise an ISO granted to you by your company. Furthermore, your gain will be treated as long-term capital gain if you meet two requirements:

1. You hold the stock for more than one year after the option is exercised.

2. You hold the stock at least two years from the date on which the option was granted.

To qualify as an ISO, the following conditions must be met:

  • The option is granted under a plan specifying the number of shares of stock to be issued and the employees eligible to receive them.
  • The stockholders approve the plan within 12 months of adoption.
  • The option is granted within the earlier of 10 years of the date the plan is adopted or the date of stockholder approval.
  • The option is exercisable only within 10 years of the date it is granted.
  • The option price must equal or exceed the stock’s fair market value when the option is granted.
  • If the employee receiving the option owns more than 10% of the voting power of the employer’s stock (not counting the option stock), the option price must equal or exceed 110% of the fair market value of the stock when the option is granted.
  • The option cannot by its terms be transferable other than at death, and it can’t be exercisable during the employee’s life by anyone else.

Tip: ISOs may cause alternative minimum tax complications. Consult with your tax pro.