Probate & Trust Law Section Conference Manual ... - Minnesota CLE

The Well-Prepared Executive: Personal Wealth Preservation Strategies
value, the Board must ignore any restrictions (e.g.,
securities law restrictions) other than those which,
by their terms, will never lapse. IRC § 422(c)(7).
This is the same rule under IRC § 83 discussed
above.
(4) Grant Date.
Because the exercise price must equal fair
market value on the grant date, it is important to
determine the grant date. In general, the grant date is
the date when the corporation completes all
corporate action constituting an offer to sell stock
under the ISO. Treas. Reg. § 1.421-7(c)(1).
(5) Conditional Grants.
A conditional grant is not a grant for ISO
purposes. For example, if an individual is granted
an ISO on the condition that he become an
employee, the grant date will not be until the first
date of employment. Treas. Reg. § 1.421-7(c)(2). It
is crucial to distinguish between conditions to the
grant (i.e., conditions precedent) and conditions to
the exercise of the option. For example, the grant
date for an executive who is hired and granted ISOs
conditioned on continued employment for 6 months
would likely be treated as the six-month anniversary
date. If the value of the stock increased during this
6-month period and the executive was given an
exercise price based on the value as of the hire date,
then the option would fail to qualify as an ISO
because the exercise price would not equal the stock
value on the grant date six months later. To avoid
this issue, employers should make clear that the
grant of the ISO is unconditional but that the
employee has to remain employed for six months to
exercise the ISO subject to any other vesting
provisions. One exception is that the grant of an
ISO conditioned on subsequent shareholder
approval will not be viewed as a conditional grant
for ISO purposes so that the grant date is when the
ISO is granted. Treas. Reg. § 1.421-7(c)(2).
c. 10-Year Grant Period.
ISOs must be granted within 10 years from
the date that the plan is adopted by the Board or
approved by the shareholders (whichever is later).
IRC § 422(b)(3).
d. 10-Year Exercise Period.
ISO agreement must state that the ISO may
not be exercised more than 10 years from date of
grant, but if the employee owns more than 10% of
the voting stock of the employer, the ISO by its
terms must not be exercisable more than 5 years
from the grant date. IRC § 422(b)(3).
7
e. Non-transferable.
ISO agreement must state that the ISO may
not be transferred except by will or by laws of
descent. IRC § 422(b)(5). The ISO agreement may
permit the employee to designate a beneficiary. The
employer can amend the ISO plan to provide ISO
holders with this alternative without the amendment
resulting in a modification of the ISO for tax
purposes. Rev. Rul. 69-648, 1969-2 C.B. 103.
f. $100,000 Per Year Limitation.
Aggregate fair market value (determined as of the
grant date) of stock that can be purchased by the
executive pursuant to ISOs exercisable for the first
time during any one calendar year (under all plans
of the employer corporation and its parent and
subsidiary corporations) may not exceed $100,000.
IRC § 422(d). In applying the $100,000 limitations,
multiple grants of ISOs are taken into account in the
order granted. IRC § 422(d)(2).
(1) For example, assume an executive is
granted 60,000 shares with a fair market value
executive price of $10 with the ISOs vesting 1/6 per
year over 6 years. In any given year, the maximum
that the employee could exercise, based on the grant
date value, is $100,000, thereby satisfying the
$100,000 per year limitation. By contrast, if the
executive vested over 3 years, the employee could
exercise, based on the grant date value, $200,000
per year, thereby failing the $100,000 per year
limitation.
(2) The ISO plan may permit more than
$100,000 per year so long as it specifies that the
excess over $100,000 will be treated as NQOs.
Notice 87-49, 1987-2 C.B. 355. The company can
designate which options are ISOs and which are
NQOs and when an ISO is exercised it can
designate the stock as ISO stock. If this is not done,
then a pro rata share of each option will be an ISO
and a pro rata share of each stock will be ISO stock.
(3) Oftentimes, the vesting and exercisability of
an ISO will accelerate upon a change in control.
The acceleration of unvested ISOs may result in
some of the ISOs being recharacterized as NQOs
under the $100,000 test. Assume in the example
above where the executive receives 60,000 ISOs at
$10 per share vesting over 6 years that the employer
is acquired at the beginning of year 3. If the
unvested 40,000 ISOs became vested on the change
of control, the employee would now have the right
to exercise $400,000 of ISOs in year 3, resulting in
$300,000 (or 30,000 ISOs) failing to qualify under
the $100,000 rule.