$100K Rule

[under construction]

What is the $100K limit?

The United States securities and tax authorities limit employees from owning greater than $100,000 worth of incentive stock options (ISOs) exercisable in a calendar year. Should an employee exceed the $100,000 restriction, the portion of the grant exceeding $100K will be treated as non-qualified stock options (NSOs). This restriction is often referred to as the $100K limit for incentive stock options. Dividing option grants that exceed the $100K threshold into ISO and NSO parts is commonly called an ISO/NSO split.

IRC §422(d)(1-3) is highlighted below:

Paragraph 1 is base rule text. In plain terms, the first paragraph states that when incentive stock options (ISOs) become available to the shareholder for exercise (via a new option grant, existing vesting schedule, etc.), the total dollar value of the option vestment (the FMV of the shares multiplied by the number of shares) is aggregated with all other ISO vestments and grants for that calendar year from the issuing company, it’s parent companies, or it’s subsidiaries.

When the dollar value of this aggregate amount exceeds $100,000, all ISOs that vest or are granted after that amount are immediately converted from ISOs to nonqualified stock options (NSOs). This aggregation is tracked from January 1 to December 31, and ‘resets’ every year.

Paragraph 2 discusses the ordering in which this occurs; the oldest $100k in options remain ISOs, and all options that vest after that amount are converted to NSOs. Paragraph 3 defines ‘fair market value’ to be the value of the securities in question as of grant date; for private companies, the value of common stock is typically defined by the most recent 409A valuation; for public companies, the value of their stock is defined by the market.The calculation for the $100K ISO limit takes into account the issue date of the grant, the number of shares that first become exercisable in a calendar year, and the fair market value (FMV) of the shares when the grant was issued.

For most situations, the calculation will be straightforward. However, there exist a number of scenarios that can make this calculation more complex.

Simple $100K limit example

An employee receives an ISO grant exercisable into 100,000 shares. The ISO grant is made on 1/1/2016 and vests over four years with a one-year cliff. The FMV of the stock on the grant date is $3.00 per share, and the grant is not early exercisable.

According to the $100K limit, this ISO grant would need to be split in 2017. On 1/1/2017, a quarter of the grant becomes exercisable based on the 1-year cliff date. Additionally, the grant vests and becomes exercisable in monthly increments thereafter. In total, there will be 47,916 shares exercisable in the calendar year. At a $3.00 price per share, the value of the exercisable shares is $143,748, which exceeds $100,000.

To satisfy the $100K limit, 14,583 exercisable shares would be disqualified and treated as NSOs. The portion treated as an ISO could have only 33,333 shares exercisable in 2017, with a value of $99,999. The employee now treats portions of their original grant differently: an ISO portion of 85,417 exercisable shares (100,000 - 14,582) and an NSO portion of 14,583 exercisable shares. The grant would now appear as:

Multiple Grants

The $100K limit applies to the total value of ISO grants held by a stakeholder “under all plans of the employer corporation and related corporations.” To better understand this scenario, let's imagine an employee received 2 grants from a company: (1) Grant A: an ISO grant exercisable into 100,000 shares issued on 1/1/2016 when the FMV was $1.00 and (2) Grant B: an ISO grant exercisable into 50,000 shares issued on 1/1/17 when the FMV was $4.00. Both grants vest over 4 years, have a 1-year vesting cliff, and no provision for early exercising. The vesting and exercise schedule for the grants would appear as follows:

In this example, Grant B will require an ISO/NSO split for 2018. When combined with Grant A, the employee has total value greater than $100,000 of shares exercisable. Grant A has $25,000 of value exercisable in 2018 (25,000 shares exercisable x $1.00 per share) and Grant B has $95,832 exercisable (23,958 exercisable shares x $4.00). The total value across grants for the employee is therefore $120,832. Because Grant B was granted after Grant A, Grant B will be split to treat a portion as an NSO of 5,208 exercisable shares with a value of $20,832 (5,208 x $4.00). The other 18,750 exercisable shares will continue to be treated as ISO worth $75,000. The 2018 ISO exercisable value of Grant A ($25,000) and Grant B ($75,000) now meets the $100,000 limit.

Multiple Grants and Cancellation

Another scenario that causes confusion for the $100K limit involves canceled grants, particularly when a stakeholder has more than one grant. Using the example above, now imagine that Grant A is cancelled on 4/1/2018. What happens to Grant B's split?

According to CFR Section 1.422-4(b)(5)(ii), the option is treated as outstanding according to its original terms until the end of the calendar year when it would have been first exercisable. This means that for 2018, Grant B will still have an ISO/NSO split as described. However, for calendar years after the cancellation, Grant A will not be included in the total value calculation.

Multiple Grants and Grant Date

Now imagine that Grant B was granted on 1/1/2015 with a 3-year cliff. All other details about the grant are the same. It might be assumed that the value of Grant A’s exercisable shares would still be calculated first since it started vesting and exercising before Grant B. One might conclude that Grant B should undergo an ISO/NSO split as shown above. This would be incorrect based on the language of the $100K limit.

The law specifies in Section 1.422-4(b)(3) that “options are taken into consideration in the order in which they are granted.” Grant B’s ISO exercisable shares should be considered before Grant A because Grant B was made on 1/1/15, whereas Grant A was made on 1/1/16. Grant A would be split in 2018 to create an NSO grant with 20,832 exercisable shares worth $20,832. In 2017, Grant B now has 23,958 ISO exercisable shares worth $95,832 and Grant A has 4,168 shares worth $4,168. The grants now satisfy the $100K limit:

Early Exercises

Imagine that an employee receives an ISO grant exercisable into 150,000 shares with a four year vesting schedule and a one-year cliff. When the grant was issued on 1/1/2016, the FMV for the common stock of the employee’s company was $1.00. At first glance, it may seem like the grant would not require an ISO/NSO split since the $150,000 notional value of the shares (150,000 shares x $1.00 per share) is distributed across 4 years. But because the ISO grant is early exercisable, the $100K limit would be exceeded on the issue date. Remember that the $100K ISO limit applies to the date a grant first becomes exercisable. In this case, all 150,000 options could be exercised into shares when the employee received the grant. The full $150,000 applies to the 2017 calendar year.

To satisfy the requirements of the $100K limit, the ISO grant will be treated as having ISO and NSO portions: an ISO grant exercisable into 100,000 shares and a NSO grant exercisable into 50,000 shares. The notional value of the ISO grant is $100,000 (100,000 shares x $1.00), which satisfies the requirement.

$100K ISO limit

At Carta, we support situations where the $100K ISO limit might apply. We use the data supplied by companies to assist with these complex situations. Company users can view ISO/NSO breakdowns in option grant details:

  • Any user with “company viewer”, “company editor”,or “legal administrator” permissions can view these details. For questions about permissions, learn more
  • Go to Securities > Equity Awards page > “option grants” tab
  • Click along the row for the desired grant, i.e. ES-121

  • Click into the “ISO/NSO split” tab of the grant details.

Option grant holders can view ISO/NSO split information from their portfolio as well:

  • Navigate to Portfolio page
  • Click on the option grant image or the option grant ID to open the grant details view
  • Click on the “ISO/NSO grant” tab

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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