Earlier this week, the Treasury Department and the IRS issued final regulations on incentive stock options ("ISOs"). These regulations finalize, with modest changes, regulations proposed in 2003.
ISOs provide employees with the ability to acquire employer stock without realizing income when the option is exercised. If the employee holds the stock for a required period, any gains on the sale of the stock are capital gains. The exercise price for an ISO must be no less than the fair market value of the underlying stock on the date the ISO is granted. An ISO plan must be approved by shareholders, and the amount of ISOs that can be granted to an employee is limited. If the employee meets the holding period requirements for capital gains treatment on the sale of the stock, the employer is not entitled to a deduction with respect to the ISO.
The final regulations include a number of minor changes from the proposed regulations, including revisions to the rules regarding maximum aggregate number of shares in an ISO plan, substitution and assumption of ISOs and modification of ISOs.
The final regulations generally will be effective on the earlier of January 1, 2006, or the first regularly scheduled stockholders meeting of the granting corporation occurring at least 6 months after the publication of the final regulations.
You may view the text of the final regulations here.