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Subject:   ISO's become NQSO's?
Date:   Mon, 07 Mar 2005
From:   Dave

I recently terminated my employment with my former employer by retiring. My employee option plan document says that "In order to retain the favorable income tax treatment of ISOs, the ISOs must be exercised on or before three months after retirement." Under the Code, do ISOs revert to NQSOs after some period after term of employment? What is the reference? If they do, then income tax withholding and employment tax withholding would apply on exercise, correct?

Answer

Date:   Mon, 14 Mar 2005

Hello Dave,

According to Internal Revenue Code Section 422(a)(2), in order to qualify as an ISO, at all times during the period beginning on the date of the granting of the option and ending on the day 3 months before the date of the exercise, the individual holding the option must have been an employee of the corporation granting the option or a parent or subsidiary of the corporation, or a successor corporation.

If the option isn't "qualified" as an ISO or an employee stock purchase plan, it is a "non-qualified" option, and taxed accordingly. As a former employee, the exercise will be subject to income tax withholding and employment tax withholding.

Good luck!

Mike Gray

For more information about incentive stock options, request our free report, Incentive Stock Options - Executive Tax and Financial Planning Strategies.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.