Page 463 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

Chapter 8. Long-Term Incentives 449

1. The plan must specify the employees or class eligible, the number of shares available
for grant, and be approved by shareholders within 12 months of date plan is adopted.
2. Grants under the plan may not be later than 10 years from adoption or approval date
of the plan (whichever is sooner).
3. The grant price may not be less than the fair market value on date of grant (110 percent
if a 10 percent shareholder).
4. The exercise period may not exceed 10 years from date of grant (5 years if the
optionee holds more than 10 percent of voting power of stock outstanding).
5. The values of the grant (i.e., grant price times number of shares first exercisable in a
year) may not exceed $100,000 per person, with limited carryover to subsequent years.
6. The optionee must be an employee and must exercise the option not later than three
months after leaving employment, one year for disability, or to term for death.
7. The option is not transferable by the optionee other than by will or the laws of descent
and distribution, and is exercisable only by the optionee during his or her lifetime.
8. The optionee incurs no ordinary income upon grant or exercise of an ISO but may be
subject to the alternative minimum tax.
9. The optionee may not sell the acquired shares sooner than two years from date of
grant nor within one year after exercise.
10. ISOs are not subject to discrimination requirements; executives may receive preferential
consideration.
ERTA also lowered the long-term capital gains tax to 20 percent and the maximum
income tax to 50 percent. The 1986 Tax Reform Act lowered the maximum income tax to 28
percent but eliminated the favorable long-term capital gains tax. The Omnibus Budget
Reconciliation Act (OBRA) of 1993 created a new top marginal tax of 36 percent but restored
a long-term capital gains tax of 28 percent. The 1997 Tax Payer Relief Act lowered long-term
capital gains rate to 20 percent for those assets held 18 months or longer while retaining a 28
percent rate for those held more than 12 months but less than 18 months. A year later the 20
percent applied to assets held more than 12 months. The 2001 Economic Growth and Tax
Reconciliation Act scaled back the maximum tax to 35 percent through 2010. The 2003 Jobs
Growth Tax Relief Reconciliation Act lowered the tax to 15 percent on dividends and long-
term capital gains through 2008; the 2006 Tax Act extended both changes through 2010.

Comparison of Statutory Stock Options
A comparison of the new statutory stock options that resulted from the 1950 Revenue Act,
the 1964 Revenue Act, and the 1981 Economic Recovery Tax Act is shown in Table 8-30.
A Closer Look at Types of Stock Options
As stated earlier in this chapter, a stock option is the right (not the requirement) given to a
person (the optionee) by a company (grantor or optioner) to purchase (exercise) a stipulated
quantity (number of shares) of the company’s stock at a stated price (grant or strike price)
over a prescribed period of time (exercise period) in accordance with stated eligibility
periods (vesting requirements). Thus, the variables are price per share, number of shares,
vesting, and term of grant. Term of grant typically varies from 5 to 10 years. The longer
period is usually associated with a slow-moving stock market, the short term with a bull
market. The other three variables have a number of possibilities, however. They include
the following.