Validation of ISO Limits
There is no limit to the number of option shares that can be granted as ISOs. However, only the first $100,000 in aggregate fair market value of shares (determined on the grant date) covered by a stock option, which is exercisable for the first time during any calendar year, qualifies as an ISO and receives preferential tax treatment. Any amounts first exercisable in excess of $100,000 are treated as NQs. If an individual quits and returns to the same organization within the same calendar year, the pre-termination ISO shares exercisable in that calendar year count against the limit even though they are no longer exercisable. The $100,000 limit is defined in the governing body rules and can be changed.
The following scenarios illustrate how Stock Administration interprets the $100,000 limit rule.
Maximum Rule Scenario
On March 6, 1995 12,500 shares are granted with an FMV of $50 and the following vesting schedule:
| Vest Date | Shares Vested | Vest Value | Value Over Limit | Shares Over Limit | % Over Limit | NQ Shares Granted | ISO Shares Granted |
|---|---|---|---|---|---|---|---|
|
3/6/1996 |
5,000 |
250,000 |
150,000 |
3,000 |
60% |
3,000 |
2,000 |
|
3/6/1997 |
2,500 |
125,000 |
25,000 |
500 |
20% |
500 |
2,000 |
|
3/6/1998 |
2,500 |
125,000 |
25,000 |
500 |
20% |
500 |
2,000 |
|
3/6/1999 |
2,500 |
125,000 |
25,000 |
500 |
20% |
500 |
2,000 |
|
Totals |
12,500 |
|
|
|
|
4,500 |
8,000 |
The NQ shares are calculated by multiplying the corresponding percentage over the limit by the number of shares that are first exercisable in each calendar year. In our example, 60 percent of 5000 shares is 3000 shares and 20 percent of 2,500 shares is 500 shares. The number of ISO shares granted is determined by subtracting the NQ shares from the shares first exercisable each year.
In the case of stock option repricing, the double counting only needs to occur in the year of the repricing. Shares exercisable in the years prior to and after the repricing do not need to be double-counted. The reprice rules are first exercisable in all years or first exercisable as of the reprice. Many organizations choose to count all periods with which shares are first exercisable from the repriced option, although this may limit the amount of shares that can be granted as ISOs in future years. You choose which method your organization uses.
Even Rule Scenario
On March 6, 1995 12,500 shares are granted with an FMV of $50 and the following vesting schedule:
| Vest Date | Shares Vested | Vest Value | Value Over Limit | Shares Over the Limit | % Over the Limit | NQ Shares Granted | ISO Shares Granted |
|---|---|---|---|---|---|---|---|
|
3/6/1996 |
5,000 |
250,000 |
150,000 |
3,000 |
60% |
3,000 |
2,000 |
|
3/6/1997 |
2,500 |
125,000 |
25,000 |
500 |
20% |
1,500 |
1,000 |
|
3/6/1998 |
2,500 |
125,000 |
25,000 |
500 |
20% |
1,500 |
1,000 |
|
3/6/1999 |
2,500 |
125,000 |
25,000 |
500 |
20% |
1,500 |
1,000 |
|
Totals |
12,500 |
|
|
|
|
7,500 |
5,000 |
In this example the NQ shares are calculated by multiplying the highest percentage over the limit by the number of shares first exercisable in each year. So, 60 percent of 5000 shares is 3000 shares and 60 percent of 2,500 shares is 1,500 shares. The number of ISO shares granted is determined by subtracting the NQ shares from the shares first exercisable each year.