Next Up Previous Contents Index
Next: Alternative Minimum Tax Up: Taxes and Such Previous: Warrants

Stock Options

  First, the history and terminology: Incentive Stock Options are the things that used to be called Qualified Options. Qualified Options were eliminated in the 70's; ISOs were authorized in 1981; and an incredible confiscatory hook was embedded in them in 1982. They are not to be confused with stock purchase plans, though they often are; when Osborne went belly-up, many people who thought they had options discovered that they were legally obliged to pay for worthless stock, with no option at all in the matter. We have an ISO Plan in operation now; if we set up a stock purchase plan, no one will be allowed to be confused between the two.

Under an ISO Plan the Board of Directors issues options which allow you to buy the stock at a set price (called the exercise price). If everyone follows all the rules exactly, you can exercise options at any time within a period specified in your option agreement; after waiting a while, you can sell the stock and pay capital gains tax on the difference between the price you paid and the price you sold for (see under Warrants).

Here are the most important of those rules that must be followed. First, the exercise price of the option must be at least the Fair Market Value of the stock as of the time when the option was issued; you hope, of course, to exercise at a time when the value is much higher, and to sell while it remains high. The option must expire within ten years after it's issued. Simple enough? Then remember that if the optionee owns 10% or more of the existing stock, the price must be at least 110% of fair market value, and the expiration must be no more than five years.

To exercise an option, send a check to the corporate Secretary (me) with a covering note to explain that you're paying this money to exercise options. We'll promptly record the sale of stock and issue a certificate. Please don't just mail or wire money to the company in the hope that we'll guess what it's for.

The time when you finally sell the stock must be (a) at least two years since the option was granted and (b) at least one year since you exercised the option. The recent change in the capital gains holding period doesn't affect (b). You also have to exercise the options First In First Out, and you can't get around this by getting the company to cancel old options before they expire. The reason for this is that a drop in the price of stock might tempt a company to cancel a lot of old, expensive options and issue new ones at the current, lower price; this is far too nice to the employees to be legal. (It's common practice to have a Vesting Period for options. This means that people can't exercise any of the options for (say) one year after the option date; then they can exercise up to (say) 25% of the option each year. The idea is to keep those bums from exercising their options and going off to take another job before the company has extracted full value from them. This is an industry norm, not a government requirement. Autodesk's vesting periods will conform to industry norms no more closely than the rest of our practices do.) That's all the important restrictions and traps, except for Alternative Minimum Tax and Section 16(b); we'll get to them later. So what if one of these rules is violated? Then [soundtrack: the Empire's theme music] the option becomes disqualified. When you exercise it, you become immediately liable for plain income tax (not capital gains) on the difference between the exercise price and the fair market value when you exercise. In the previous example, you exercise a $.10 option when the stock is trading for $5.00; whether or not you sell, you have income at that moment equal to $4.90, on which the federal tax could be up to $2.45. If you ever sell, your gain or loss will be computed against that $5.00 value rather than the $.10 exercise price. But what if the stock isn't registered, and it's illegal (as well as impossible) to sell it? No problem; the government will be glad to take your house if you can't raise the money to pay the tax on your non-existent gain.

If this happens to you, though, all is not lost: the company gets a tax deduction.


Next Up Previous Contents Index
Next: Alternative Minimum Tax Up: Taxes and Such Previous: Warrants

Editor: John Walker