Contents

1. Take Stock of Estate Planning Strategies for Options
2. What is a Disqualifying Disposition of Incentive Stock Options?
3. Receive our tax newsletters by Email
4. Search form
5. Non-Qualified Stock Options - TurboTax Tax Tips & Videos

In these circumstances, the service provider has not incurred the risk of a beneficial owner if the value of the property declines substantially. Determine if there was transfer of stock options to a related person. Determine whether there has been a reduction in the purchase price of a note used to acquire employer stock. Under Treas. See Rev. The election must be made no later than 30 days from the date the property is transferred to the service provider, with no extensions.

See Revenue Procedure Rev. Determine whether a substantial risk of forfeiture exists depends on the facts and circumstances. Generally, a substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, upon the future performance or refraining from performance of substantial services by any person, or upon the occurrence of a condition related to a purpose of the transfer.

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Property is not considered transferred if it is subject to a substantial risk of forfeiture, and at the time of transfer, the facts and circumstances demonstrate that the forfeiture condition is unlikely to be enforced. See Treas.

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Individual s that qualify as an executive under the section 16 b of the Securities Exchange Act of could be subject to suit if sold the stock at a profit within six months after the purchase of the stock. Lapse Restrictions are restrictions other than non-lapse restrictions see below and include restrictions that carry a substantial risk of forfeiture.

Non-Lapse Restrictions will never lapse and requires the holder of the stock to sell, or offer to sell, the stock at a price determined under a formula. They are not considered substantial risks of forfeiture and never postpone the recognition of income, therefore, the service provider recognizes income immediately upon grant and the company is allowed a deduction. A Non-Lapse Restriction is not dependent upon the service provider performing services for a specified number of years. Rather, the restriction will terminate upon the occurrence of a specific event such as a change in control, termination of employment, or death of the service provider.

A common Non-Lapse Restriction generally with a non-public employer is when an employer requires the employee to sell the stock back to the employer at book value whenever the employee wishes to dispose of it for any reason. In this case, book value will be considered FMV when determining the amount included as compensation in the service provider's gross income. The employee will recognize as compensation the difference between book value and any amount paid for the stock. Dividends from restricted stock. If an employee or independent contractor receives dividends or other income from substantially non-vested restricted stock, the amounts are considered additional compensation to the individual and must be included in income, are subject to employment taxes, and may be deductible by the corporation.

Once the restricted stock award vests, the dividends are treated as dividend income rather than compensation. In order to determine if there is an issue with stock options, the examiner must determine the type of stock option received by the individual. The exercise of Statutory Options does not result in income compensation or income tax to the employee, and the employer may not take a compensation deduction. See Notice , C. For information regarding employment taxes, see Notice The examiner should review the terms of a Statutory Option and verify that it is not allowable for it to be treated any other way than as a Statutory Stock Option.

A qualifying disposition occurs when the employee holds the stock for at least two years from the date of grant and one year from the date of exercise. If the specific holding period requirements are met, then the employee recognizes capital gain or loss on disposition of the stock but there is still no deduction for the employer. The excess of the FMV of the share on the date of its disposition over the amount paid for the share, or.

If the option price is not fixed and determinable at the time the option is granted, the option price will be computed as if the option had been exercised on the grant date. See Notice Any additional gain on the disposition of the stock is characterized as capital gain.

The employer receives no tax deduction for the compensation recognized by the employee under this special rule. A failure to meet the holding period requirements results in a disqualifying disposition of the stock purchased by exercising a Statutory Stock Option. In that event, the employee has compensation ordinary income on the date of the disqualifying disposition equal to the difference between the exercise price and FMV of the underlying stock on the date of exercise.

If the stock at issue was restricted i. In the event of a disqualifying disposition, the employer is entitled to a corresponding wage deduction. Pursuant to Treas. This limit is determined based on the FMV of the stock at the time the option is granted and not at the time the option vests. At the time of exercise, this results in ordinary income to the employee and a wage deduction to the employer.

The main US securities laws applicable to an employee share plan are the following:. Securities Exchange Act of Securities Act. Securities Exchange Act of Exchange Act. Securities Act Public companies. The Securities Act generally requires that US public companies register shares offered under an employee share plan.

Take Stock of Estate Planning Strategies for Options

Typically, US public companies will register their shares by filing a Securities Exchange Commission SEC Form S-8, which is a short-form registration statement that can be filed electronically and is effective immediately. A Form S-8 is filed if a company adopts a new employee share plan and whenever additional shares are reserved for future issuance under the employee share plan. One of the main components of a Form S-8 is a prospectus that must be delivered promptly to all participants in the employee share plan, but need not be filed with the SEC.

Private companies. Private companies often rely on Rule of the Securities Act Rule as an exemption from the requirement to register their securities with the SEC. There are also exemptions under Regulation D and Regulation S that both public and private companies may rely on to avoid registration with the SEC see Question The Exchange Act contains ongoing public reporting requirements, such as:.

What is a Disqualifying Disposition of Incentive Stock Options?

Quarterly reports on a Form Q. Current reports on a Form 8-K to report certain material events. Proxy statements relating to a company's annual shareholder meeting. Blue sky state securities laws Similar to federal securities law, each state also has a requirement that shares offered under an employee share plan must either be registered or qualify for exemption from registration. Private companies, on the other hand, must register their shares with the applicable state in which an equity grant is made or rely on an exemption from registration.

The most common exemptions from registration are:.

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Self-executing Rule exemption: if the grant of the equity award qualifies for exemption under Rule , it will also automatically qualify for exemption under that state's securities laws and no filing is required. Equity grants made to a current service provider pursuant to a compensatory benefit plan, such as an employee share plan. To claim an exemption from state registration, a limited number of states require a notice filing with the state along with the payment of a small fee.

Certain other states impose additional requirements, such as limitations on the number of recipients of equity awards or specific plan terms. For example, to claim an exemption from registration in California, an employee share plan must contain certain specific plan terms, most of which largely mirror the ISO regulations, but also include requirements regarding proportionate adjustments for certain specific corporate transactions and minimum post-termination exercise periods for options. Are there any exemptions from securities laws or regulations for employee share plans?

If so, what are the conditions for the exemption s to apply? To avoid registration, private companies must rely on a securities exemption. The securities exemptions for employee share plans fall into one of the following categories:. Rule Rule Rule is the main exemption from registration under the Securities Act for private companies. Equity awards granted under an employee share plan to employees, directors, consultants and other service providers for compensatory purposes are eligible for the Rule exemption from registration. Rule is only available for grants to service providers who are natural persons and not legal entities.

The number of securities a private company can sell under the Rule exemption from registration is subject to two limitations:. Hard cap limit. The aggregate sales price or amount of securities that can be sold in reliance on Rule during any consecutive month period must not exceed the greatest of the following:. USD1 million;. The aggregate sale price is determined on the grant date of the option and valued based on the exercise price.

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Therefore, the entire value of the option number of shares multiplied by the exercise price is included as of the grant date for purposes of this calculation. Soft cap limit. The company must provide certain detailed disclosure see below to each recipient if the aggregate sales price or amount of securities sold during any consecutive month period in reliance on Rule exceeds USD10 million.

Again, the "sale" of an option for these purposes is deemed to occur on the grant date of the option, and the option is valued based on its exercise price. Information disclosures under Rule soft cap limit. A company granting options in excess of the soft cap limit can rely on Rule only if certain disclosures are made to all individuals who received securities in reliance on Rule The required disclosures consist of:.

A copy of the stock plan and award agreement. Because financial statements must be no more than days old, the financial disclosure should be updated on a quarterly basis. The SEC has stated that companies must provide these disclosures to all individuals receiving equity awards in the offering period if the company believes that it will exceed the USD10 million limit during any coming month period.

The penalties for non-compliance with Rule could result in rescission rights for each of the participants, which would require the company to offer to repurchase shares and unexercised options plus interest, which can be extremely costly for the company as it would require compliance with each applicable state's rescission laws. Many state blue sky laws also require compliance with Rule , so a violation could result in non-compliance with state securities laws as well.

Rule strategy. To reduce the pressure on the Rule limits, the following strategies can be taken:. Consider adopting a fixed month period for example, the calendar year or fiscal year as opposed to a rolling month period. Identify grants to accredited investors and move such grants to another securities exemption such as Regulation D see below, Regulation D.

Do not count options that are cancelled or forfeited. To the extent options will be granted to persons outside the US, consider Regulation S safe harbour see below, Regulation S. Section 4 a 2 private placement exemption Section 4 a 2 of the Securities Act exempts from registration "transactions by an issuer not involving any public offering". This is the most commonly used exemption for grants to entities and other non-Rule issuances.

Non-Qualified Stock Options - TurboTax Tax Tips & Videos

To qualify for this exemption, the recipient must meet all the following conditions:. Either have enough knowledge and experience in finance and business matters to be a "sophisticated investor" for example, able to evaluate the risks and merits of the investment , or be able to bear the investment's economic risk.

Have access to the type of information normally provided in a prospectus for a registered securities offering. Agree not to resell or distribute the securities to the public. This exemption is intended to be used for a limited number of one-off grants, although there is no bright line rule. The advantage of this exemption is that no Form D is required to be filed with the SEC and individual states.

However, if a company offers securities to even one person who does not meet the requirements for this exemption, the entire offering may be in violation of the Securities Act. Therefore, some companies may prefer to rely on the objective standards provided under Regulation D see below.